Paul Krugman: Edge of the Abyss

Can we buy enough time to implement a real solution to the financial crisis?:

Edge of the Abyss, by Paul Krugman, Commentary, NY Times: As recently as three weeks ago it was still possible to argue that the state of the U.S. economy, while clearly not good, wasn't disastrous... But that was then.

The financial and economic news since the middle of last month has been really, really bad. And what's truly scary is that we're entering a period of severe crisis with weak, confused leadership. ...

There's growing evidence that the financial crunch is spreading to Main Street, with small businesses having trouble raising money and seeing their credit lines cut. And leading indicators for both employment and industrial production have turned sharply worse, suggesting that ... the economy, which has been sagging since last year, was falling off a cliff.

How bad is it? Normally sober people ... say that the economy seems to be on “the edge of the abyss.” And the people who should be steering us away from that abyss are out to lunch.

The House will probably vote on Friday on the latest version of the $700 billion bailout plan..., ... now ... the Paulson-Dodd-Frank-Pork plan (it's been larded up since the House rejected it...). I hope that it passes, simply because ... another no vote would make the [financial] panic even worse. But that's just another way of saying that the economy is now hostage to the Treasury Department's blunders.

For the fact is that the plan ... is a stinker - and inexcusably so. The financial system has been under severe stress for more than a year, and there should have been carefully thought-out contingency plans ready ... Obviously, there weren't: the Paulson plan was clearly drawn up in haste and confusion. And Treasury officials have yet to offer any clear explanation of how the plan is supposed to work, probably because they themselves have no idea what they're doing.

Despite this, as I said, I hope the plan passes, because otherwise we'll probably see even worse panic... But at best, the plan will buy some time to seek a real solution...

And that raises the question: Do we have that time?

A solution ... will ... almost surely involve the U.S. government taking partial, temporary ownership of [the financial] system, the way Sweden's government did in the early 1990s. Yet it's hard to imagine the Bush administration taking that step.

We also desperately need an economic stimulus plan to push back against the slump in spending and employment. And this time it had better be a serious plan that doesn't rely on the magic of tax cuts, but instead spends money where it's needed. (Aid to cash-strapped state and local governments, which are slashing spending at precisely the worst moment, is also a priority.) Yet it's hard to imagine the Bush administration, in its final months, overseeing the creation of a new Works Progress Administration.

So we probably have to wait for the next administration, which should be much more inclined to do the right thing - although even that's by no means a sure thing, given the uncertainty of the election outcome. (I'm not a fan of Mr. Paulson's, but I'd rather have him at the Treasury than, say, Phil "nation of whiners" Gramm.)

And ... it will be almost four months until the next administration takes office. A lot can - and probably will - go wrong in those four months.

One thing's for sure: The next administration's economic team had better be ready to hit the ground running, because from day one it will find itself dealing with the worst financial and economic crisis since the Great Depression.

Comments

[Easy Money]

Austrian economics predicted the crisis credit would cause. Truth be told, ABCT and Austrian writings on credit booms offer the only real explanation of what we have witnessed. It's therefore useful to see what they say about the remedy.

Unfortunately they offer no easy way out. Mises said, "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

[kotzabasis]

Paul Krugman laments that we are “entering a period of severe crisis with WEAK and CONFUSED leadership.” And I would respond that the people in the media like himself should be warning us about the abyss instead of being out playing their politics. Only few moments after the speech of President Bush warning Americans of the imminent perils of the economy and of the absolute necessity for Congress to pass the legislation immediately, as TIME was a crucial factor for the success of the plan-with which Krugman himself agrees-what Krugman did? He ingloriously tried to associate the speech of Bush with the so called lies of the war in Iraq. Thus like so many other WEAK commentators lengthening the credibility gap that was already extant between the President and many Americans and CONFUSING the latter about the veracity of Bush about the economic crisis, when Krugman himself knew that what the President was saying was the absolute truth.

TU NE CEDE MALIS

[Oupoot]

IMHO, there are gaps in the plan, but also on the critique of the plan. All the commentators have identified various aspects that an effective plan need to address, but in most cases these address different aspects of the crisis. Actions that have a short term, medium term and long term impact all need to be implemented now. It is not a case of lets now only focus on the short term actions and only later on the medium and long term issues. Similarly, we should not focus only on the medium to long term corrective actions and forget/ignore the short term actions that is also very important. The economy is not like surgery where we now do the "field hospital/stop the blood/trauma" actions on the patient and only later do we consider the options for corrective plastic surgery. Certain things in the economy take a long time to implement/have an effect. We all understand that: monetary policy impact is short-med term and already nearly exhausted. On the other hand, fiscal policy takes time to have an impact (lead of at least 2 years for most fiscal policy options). There are exceptions, such as the a tax rebate that will have an immediate impact (i.e. within the next 12 months) though it will be short lived. Implementing fiscal responses (e.g. building roads, railways, schooling, even changing international trade pacts) will take a long time to have an effect (about 3-5 years at least). We cannot leave the medium to long term things for later, cause then it will take double that time to actually start having an effect. In additon, the economic situation could already have change by that time the medium and long term actions are having its impact.

In many respects, the changes to the plan in the past 2 weeks addresses some of the medium/long term corrective actions which were definitely absent from the original plan, but in many respects, these medium to long term actions are extremely flawed. Both candidates' economic team need to start developing their plans now. While short term interventions that may be required may change between now and January, most of the medium and long term corrective actions will not, and those need to be implemented asap when the new administration take over (to replace the flawed proposed actions in the current plan).

[Lafayette]

The 1/40 Club

Perhaps there’s a silver lining in all this mess? Perhaps stepping up to the brink was a necessary evil?

To remind Americans that their unshakable faith in the Free Market Solution is perhaps not as solid as they would like to think?

I have often opined that between the US and Europe there was a middle-ground somewhere that was far more suitable to both. Europe is recovering from far too much Interventionist Statism. The US will now take a few years to recover from Unbridled Capitalism.

Let’s face it – Europe, with the singular exception of England, arrived at the conclusion that too much of an onus on the individual accumulation of wealth was AS important as focussing on Income Inequality. This is derived from an innate sense of Social Justice, that we are not only an economy but a society – and as a society no one or group of peoples should be left so far behind that even a lifetime of work will never allow them to catch-up.

Or that some will get so far ahead, that they become exceptions to society. The American Dream has always been heavily weighted towards individual success, and no better place can be found for achieving success than in business and commerce.

What we must ask ourselves, however, is this: “At what price is that success achieved?”

There is a group of exceptions that I will call the “1/40 Club”. This name is derived from the fact that 1% of the earth’s population currently possesses 40% of its wealth. And, of that large number, guess where most of them live? No, not China. Guess again.

The elitists are not those of us who contribute to this blog, but those who are members of the 1/40 Club. They will never be like you or me. They really could care less about blogs and the preoccupations of those who employ them to either debate or complain.

Income inequity, I never tire of remonstrating, is the rot attacking any society. People can live with millionaires. It inspires many. But, the hallucinatory riches in a country so possessed of abject poverty, as is the US, cries out for Social Justice and Fairness.

Let’s hope the next Dem PotUS will have the courage to place Social Justice high, very high on his list of Things To Do.

[bakho]

Outpoot seriously overestimates the time between stimulus and funding for state projects that are ALREADY ON THE TABLE. For example, California MUST borrow money IMMEDIATELY or they will have to take some combination of steps that will DELAY payroll/purchases/projects. This is the LAST thing an economy going into recession needs. A stimulus that keeps states from CUTTING BACK on current plans or instituting SALARY FREEZES, HIRING FREEZES or other measures that EXACERBATE a recession can have a very short lead time because it is only a paper transfer for Congress to tell states that they have access to this pool of money immediately.

States typically MUST run balanced budgets and are FORCED to cut back in recessions because of revenue loss. Replacement of lost state revenue could be accomplished quickly and is on type of stimulus that would help a lot and could be implemented almost overnight.

[Priorities]

"...with small businesses having trouble raising money and seeing their credit lines cut."

Yet credit to small businesses is still not being prioritized. Our limited credit line from the rest of the world is still being wasted trying to re-inflate non productive bubbles. If this keeps up, we will wind up in the Great Depression part II.

[Abra Cadabra]

And this time it had better be a serious plan that doesn't rely on the magic of tax cuts, but instead spends money where it's needed. (Aid to cash-strapped state and local governments, which are slashing spending at precisely the worst moment, is also a priority.)

Seriously? Like the magic of debt financing to give aid to over zealous spending at state and local levels. Which in no doubt occured where real estate appreciation went through the roof.

So there you have it folks. Crowd out the productive sector or the economy to give money to worthless government bureaucrats.

[macquechoux]

Bakho, I believe California has had spending problems for years. The state has never learned to live & legislate within their financial means. Every time there is an economic slowdown there is a blizzard of articles about how the states, their women and children,the poor, and public services and God knows what else is going straight to Hell. Old age does have its benefits as I have noticed over the years after every economic slow down the states somehow manage to survive and most resume spending money like drunken sailors. Unsustainable, a word much in current favor, spending only guarantees the next crises will larger.

[ken melvin]

Surely 'tis kismet that when we most need leadership we have such giants as GWB and Ahnold.

[bakho]

Lenders gouging the states with high interest rates is counterproductive because it means less money that the states have to spend on employees and state projects.

says...

We have begun a recession, which I had hope might just be avoided till Lehman Brothers was allowed by the Administration to fail. Another loss of jobs, 159,000 jobs lost last month, making for 9 months of a labor market recession. A labor market that had never been strong through the Administration, through recovery and expansion, has become dramatically weak.

There were an average of 225,000 jobs created for the 96 months of the Clinton years, while the finest 52 months of the Bush years counted for an average of 160,000 jobs created. We are in serious trouble.

[anne]

The trouble is compounded because we have been in the midst of a sustained high government spending, deficit building, low and lowered taxes, low interest rate, weak dollar, high corporate profit, high corporate savings period that has never resulted in growth comparable to growth experienced in every expansion for 60 years.

[That was me, and my signing-in mistake.]

[hari]

Paul is giving away his professional secret, ie. recession is imminent, if not already here, and will be devastating in terms of unemployment and lost social security of the working class.

Therefore, let's not pretend as if things are going to get better once House of Reps approve $700 Billion rescue Plan, as now modified by the Senate.

It won't and recession is likely to last into 2010...and if you follow Rogoff's diagnosis in a separate thread, contraction of the hi fi sector is not only desireable but imperative to restrucuture the economic malaise.

It's advisable to start considering what is likley to continue to play an institutional role in financial sector and what must be discarded.

I've discarded, some time ago, hedge funds and investment banks and financial engineering instruments such as *derivatives* without any regulatory oversite/audit/control.

[Jas Jain]

--
"As recently as three weeks ago it was still possible to argue that the state of the U.S. economy, while clearly not good, wasn't disastrous... But that was then."

Only econ-Crooks thought that. Some of us have known it for a long time. Here are my comments from 2005 editorial:

"You know that a person, or a society, is marching on the road to bankruptcy when that person, or society, over a long enough period, not only has to borrow all of the interest payments but also has to borrow more for discretionary consumption. Such is the state of more than half the American middle-class households and the US government. The situation of the former is much more immediate and that of the latter is years away. US govt. debt as a percent of GDP is lot lower than many other governments, while the American household debt is the worst in the world with the possible exceptions of UK and Australia (I don’t have the data on these)."

Economists, as a group, are a bunch of dopes in the areas of economics, investments and political systems. They are very much the leaders in being born-and-bred American dopes.

Jas

[me]

"Yet credit to small businesses is still not being prioritized. Our limited credit line from the rest of the world is still being wasted trying to re-inflate non productive bubbles. "

Indeed. I read this morning that France has a small business package, while all we worry about is the bankers.

The thing I don't get about Krugman is he wants to spend a trillion dollars to buy time to do it right. How much will that cost and where does he propose the money come from for that?

[Jas Jain]

--
“America's financier caste will live to fleece another day.”

http://www.atimes.com/atimes/Global_Economy/JJ02Dj02.html

These fraudsters, “raised in a culture of fraud,” need to be hunted down and eradicated if Americans want to restore the prosperity of the middle-class that is in the process of being decimated. For those who are optimistic about America’s future, while these fraudsters are alive and well, I say: Audacity of Dopes!

Jas

[Brandon]

Can they do a bank freeze? I read at http://www.gotoguy.com/?p=367 that next week they might start a economic emergency situation and stop all banking activity. Scary

[dd]

Why is it foreign media is more informative than domestic? The WSJ is now reduced to a blog with a few stories and so it is the FT, once again that provides a glimmer inside the panic:
Settlement day approaches for derivatives
The $54,000bn credit derivatives market faces its biggest test this month as billions of dollars worth of contracts on now-defaulted derivatives on Fannie Mae, Freddie Mac, Lehman Brothers and Washington Mutual are settled.
Because of the opacity of this market, it is still not clear how many contracts have to be settled and whether payouts on the defaulted contracts, which could reach billions of dollars, are concentrated with any particular institutions.
According to dealers, insurance companies and investors such as sovereign wealth funds, which are widely believed to have written large amounts of credit protection through credit default swaps on financial institutions, could have to pay out huge amounts.
"There is a lot at stake," said an executive at one big dealer. "This is a crisis time, and if these auctions do not go well, or if the amounts investors and dealers have to pay is seen as not being fair, it could have further negative repercussions on the CDS market."
snip
"The amount of contracts outstanding that reference Fannie Mae and Freddie Mac alone is estimated to be up to $500bn. The default was triggered under the terms of derivatives contracts by the US government's seizure of the mortgage groups, even though the underlying debt is strong after the explicit government guarantee.
The CDS contract settlement could result in billions of dollars of losses for insurance companies and banks that offered credit insurance in recent months."
http://www.ft.com/cms/s/0/6beabcdc-8f51-11dd-946c-0000779fd18c.html?nclick_check=1

Hank will drive us all to the poor house to save his precious.

[dd]

Is it any wonder that inter-bank lending is nonexistent what with billions of unknown liability about to materialize? I was hoping that Hank's takeovers were strategic and that he guessed correctly on merging the "winners" with the "losers" to net out this mess; but it appears perhaps that the Lehman negotiations were a tipping point. Just a guess.

[anne]

"As recently as three weeks ago it was still possible to argue that the state of the U.S. economy, while clearly not good, wasn't disastrous... But that was then."

This was precisely what I was arguing, and precisely what was worth arguing. Even the labor market recession begun in January 2008, had been far less pronounced than in general recessions before. What was encouraging was the general growth that was then being sustained and the consideration this could continue. Abandoning and losing Lehman Brothers appears to me to have been the turinng point.

[dd]

To hazard another guess, it appears that the collapse of the two Bear hedge funds were the warning shots and that bears out given John Paulson's hedge fund gains in August 2007 (note that John was previously with a managing director at Bear.see:
http://www.bloomberg.com/apps/news?pid=20601087&sid=at25NTB51Hwk&refer=home). Certainly the knowledge was there to be profited from but for some reason has not been used to defuse further deterioration.

That Bear was rescued and not Lehman shows perhaps that Hank is not the independent arbiter that is now needed.

[anne]

http://krugman.blogs.nytimes.com/2008/10/03/a-grim-morning/

October 3, 2008

A Grim Morning
By Paul Krugman

Double plus ungood news on multiple fronts this morning. The credit crunch is getting worse: LIBOR jumped again, the TED spread is at a new record. Bad news on employment: payrolls down 159,000, average work week down, official unemployment rate flat at 6.1 percent but broad measure (U6) up from 10.7 to 11.

We are going over the edge.

[Yes, I am worried.]

[anne]

DD:

"That Bear was rescued and not Lehman shows perhaps that Hank Paulson is not the independent arbiter that is now needed."

Precisely, but more so the matter is in the midst of a financial crisis apparent since spring and summer 2007, neither Bear nor Lehman should have been allowed to fail for the sake of the economy, as the Japanese understood in the 1990s and Robert Rubin stressed then at Treasury. The matter was not ethics, but protecting liquidity which the Japanese did brilliantly.

[Patrick]

Was it the failure of Lehman that caused the fragility of the system or did it simply bring it to light?

I'm by no means an expert, but it looks to me like the credit derivatives egg needs to be unscrambled for there to be an end to all this. Whether that is even possible, I really don't know.

[anne]

LIBOR is London interbank offered rate, while the TED spread is the difference between the interest rates on inter-bank loans and short-term U.S. government debt ("T-bills").

The employment report is at http://www.bls.gov/news.release/empsit.toc.htm

[anne]

"Was it the failure of Lehman that caused the fragility of the system or did it simply bring it to light?"

Fine question, that is answered in telling of the fragility that was surely and evidently there, more so possibly than even in Japan, while the failure added to the fragility and to the appearance of fragility.

[anne]

"I'm by no means an expert, but it looks to me like the credit derivatives egg needs to be unscrambled for there to be an end to all this."

That is so, but will take years which is why protection was and is essential. I would argue the expansion of the derivatives market since, say, 1994 has made this crisis more dangerous than that in Japan.

[anne]

http://krugman.blogs.nytimes.com/2008/10/03/the-track-record/

October 3, 2008

The track record
By Paul Krugman

Feel the boom [Chart]

This chart shows U6, the broadest measure of unemployment and underemployment from the Bureau of Labor Statistics. (No data available before 1994.) You can still argue that presidents really don’t have that much influence on the economy. But remember, Bush supporters eagerly claimed that downward stretch from 2003 to 2006 — coinciding with the worst excesses of the housing bubble — as proof that tax cuts work. Live by the business cycle, die by the business cycle.

[dd]

What is very puzzling is that the Fed has long known about the approaching derivatives hurricane and there are many missives, plans and assurances. Geithner and Corrigan have been at it for years and years. Then too there was LTCM, the first derivatives collapse and Enron the second. But still all were insistent that private solutions were the way forward.
Very strange.

[anne]

http://www.nytimes.com/2008/10/03/business/03sec.html?ref=business&pagewanted=print

October 3, 2008

Agency's '04 Rule Let Banks Pile Up New Debt, and Risk
By STEPHEN LABATON

"We have a good deal of comfort about the capital cushions at these firms at the moment." — Christopher Cox, chairman of the Securities and Exchange Commission, March 11, 2008.

As rumors swirled that Bear Stearns faced imminent collapse in early March, Christopher Cox was told by his staff that Bear Stearns had $17 billion in cash and other assets — more than enough to weather the storm.

Drained of most of its cash three days later, Bear Stearns was forced into a hastily arranged marriage with JPMorgan Chase — backed by a $29 billion taxpayer dowry.

Within six months, other lions of Wall Street would also either disappear or transform themselves to survive the financial maelstrom — Merrill Lynch sold itself to Bank of America, Lehman Brothers filed for bankruptcy protection, and Goldman Sachs and Morgan Stanley converted to commercial banks.

How could Mr. Cox have been so wrong?

Many events in Washington, on Wall Street and elsewhere around the country have led to what has been called the most serious financial crisis since the 1930s. But decisions made at a brief meeting on April 28, 2004, explain why the problems could spin out of control. The agency's failure to follow through on those decisions also explains why Washington regulators did not see what was coming.

On that bright spring afternoon, the five members of the Securities and Exchange Commission met in a basement hearing room to consider an urgent plea by the big investment banks.

They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserve as a cushion against losses on their investments. Those funds could then flow up to the parent company, enabling it to invest in the fast-growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.

The five investment banks led the charge, including Goldman Sachs, which was headed by Henry M. Paulson Jr. Two years later, he left to become Treasury secretary.

A lone dissenter — a software consultant and expert on risk management — weighed in from Indiana with a two-page letter to warn the commission that the move was a grave mistake. He never heard back from Washington.

One commissioner, Harvey J. Goldschmid, questioned the staff about the consequences of the proposed exemption. It would only be available for the largest firms, he was reassuringly told — those with assets greater than $5 billion.

"We've said these are the big guys," Mr. Goldschmid said, provoking nervous laughter, "but that means if anything goes wrong, it's going to be an awfully big mess."

Mr. Goldschmid, an authority on securities law from Columbia, was a behind-the-scenes adviser in 2002 to Senator Paul S. Sarbanes when he rewrote the nation's corporate laws after a wave of accounting scandals. "Do we feel secure if there are these drops in capital we really will have investor protection?" Mr. Goldschmid asked. A senior staff member said the commission would hire the best minds, including people with strong quantitative skills to parse the banks' balance sheets.

Annette L. Nazareth, the head of market regulation, reassured the commission that under the new rules, the companies for the first time could be restricted by the commission from excessively risky activity. She was later appointed a commissioner and served until January 2008.

"I'm very happy to support it," said Commissioner Roel C. Campos, a former federal prosecutor and owner of a small radio broadcasting company from Houston, who then deadpanned: "And I keep my fingers crossed for the future."

The proceeding was sparsely attended. None of the major media outlets, including The New York Times, covered it.

After 55 minutes of discussion, which can now be heard on the Web sites of the agency and The Times, the chairman, William H. Donaldson, a veteran Wall Street executive, called for a vote. It was unanimous. The decision, changing what was known as the net capital rule, was completed and published in The Federal Register a few months later.

With that, the five big independent investment firms were unleashed.

In loosening the capital rules, which are supposed to provide a buffer in turbulent times, the agency also decided to rely on the firms' own computer models for determining the riskiness of investments, essentially outsourcing the job of monitoring risk to the banks themselves.

Over the following months and years, each of the firms would take advantage of the looser rules. At Bear Stearns, the leverage ratio — a measurement of how much the firm was borrowing compared to its total assets — rose sharply, to 33 to 1. In other words, for every dollar in equity, it had $33 of debt. The ratios at the other firms also rose significantly.

The 2004 decision for the first time gave the S.E.C. a window on the banks' increasingly risky investments in mortgage-related securities.

But the agency never took true advantage of that part of the bargain. The supervisory program under Mr. Cox, who arrived at the agency a year later, was a low priority.

The commission assigned seven people to examine the parent companies — which last year controlled financial empires with combined assets of more than $4 trillion. Since March 2007, the office has not had a director. And as of last month, the office had not completed a single inspection since it was reshuffled by Mr. Cox more than a year and a half ago....

[Winslow R.]

Why are we targeting financial sector profits?

I could give you 'a million logical' arguments of how targeting financial sector profits indirectly targets Mainstreet.

All of them lead to more lending to Mainstreet.

We don't need more lending to Mainstreet through a disfunctional financial sector. We need more income to Mainstreet.

Payroll tax holiday would be a good start until we get a new President.

[Organic George]

It was never Paulson's plan, it was drafted at the WH by the neo cons to destroy all social programs in the US.

They saw an opportunity to use the crisis to drown the Federal government in Wall St red ink.

These ideologues don't care if there is a financial melt down since they view a Phoenix rising from the ashes with out social programs.

I know people like this and they are passionate about tearing down the social programs at any cost, so their free market ideas can flourish.

[Winslow R.]

There must be some economic theory on the game of 'chicken'.

How close is Krugman willing to get to the edge to find out if the financial sector is willing to go over the ledge?

Military generals are willing to send the masses into a slaughter for the 'greater good'. Why not economists? The financial guys don't seem to have these same qualms.

What does this say about our willingness to sacrifice (especially if its not me) in order to move forward?

How can an economic society, with such weak kneed leaders, hope to bring about real change?

Do we really need to 'chicken out' right now?
Where are our economic leaders to tell us how close we are standing to the abyss and could we (me especially) survive the fall?

[Bruce Wilder]

w: "willingness to sacrifice (especially if its not me)"

Look at the first comment in this thread.

[anne]

Essentially, while the decline will continue for some while, we have already undone the remarkable economic gains of the Clinton years. I never would have imagined this was possible, and do not really understand how it could be so since the Bush expansion was continually weaker than makes sense to me in terms of domestic conditions and in terms of a wonderfully growing international economy. Nonetheless the relative weakness was always there, especially reflected in the labor market, and there is a full-out contraction now.

My sense is that there contraction could only be significantly limited by Japan-like or New Deal-like spending, beyond military spending that has been relatively ineffective in economic terms. Such a spending program is not being seriously politically discussed.

[yamada]

For real solution, why not make use of FRB’s profit when they print dollar?

Bubble is caused by peoples’ expectation that the price of asset(real estate) will soar in future, with pouring high-powered money to the asset side of economic units’ balance-sheet. So, to solve this problem, such asset bubble on economic units’ balance-sheet must get ridden of, by the new system as below. Though it may be seen contradictory, high-powered money enables to work this new system. Please remember, no one has ever invented the solution in history.

1. Every economic unit’s(including banks) assets that caused the bubble(real estate or CDO et al) on balance sheet should be evaluated on mark to market basis by the authorization of a third party(maybe auditor), which brings about some insolvent(i.e. debt section surpasses asset section on balance sheet) economic units.
2. FRB decide to write off a certain amount of the loans to the banks, which amount distributed to each bank according to the amount of each banks’ insolvency, calculated on 1.
3. Every bank that gets profit from written off should next enforced to, by using the profit from written off as original fund, write off its loans to its each debtor, according to the amount of insolvency of each debtor. If the bank is unable to use all the written off profit it earned, the remainder is taxed all.
4. Other economic unit that gets profit from the written off by the bank should next enforced to, by using the profit from the written off as original fund, write off it’s loan(or trade claim) to its each debtor, according to the amount of insolvency of each debtor. If the economic unit is unable to use all profit it earned, the remainder is taxed all. These processes are to be repeated operationally.
5. In consequence, the bubble portion of the targeted asset is extracted from the economy, and is transformed to tax.
6. The tax claims is finally assigned to FRB. It’s up to FRB how they dispose of their above claims, considering the situation of economy, of each bank and of each economic unit. Talking about the latter two, as a option the FRB should examine the possibility of the bank’s and economic units’ turnaround, together with the other creditors, remaining desirable debt to the bank’s and economic unit(empirically it's ten to fifteen times annual earnings before interest, taxes, depreciation and amortization, known as EBITDA, of the economic unit), writing off the rest debt, with taking into account the value of disposable collateral(that do not accrue earnings), of guarantor and of consolidated basis.
7. Every write off must be supervised and tracable by centralized function of the system. So every write off must be executed through this function. Every write off may be done through this function, which exist on internet for access.
8. For cross-border. For each non-residential economic unit, the amount of write off should also be calculated in the same way as 4. , on the only cause from specific asset depreciation in the resident country. Economic unit that will be written off should next write off in the same booked currency. In case profit of the written off exists on the non-residential economic units, it's taxed and absorbed by the foreign(=non-residential) government and handed over to the sovereign(=residential) government of the currency, based on treaty.
9. In case inflation expectation exists, the system enables FRB to on one hand raise benchmark rate to cope with inflation expectation, on the other hand restructuring the balance sheets of economic units.
10. FRB should carefully watch the rate of the number of insolvent economic units to the number of all economic units in the US, when deciding the amount of the loans(trade claim) written off on 2.
11. FRB print greenbacks(bring about profit) correspond to the write-offs, which return to FRB as tax claim, so these greenbacks could be stored to the safe in FRB forever.

For further details, please see the blog as below:

http://reversewealtheffect.blogspot.com/

[LDIS]

I find all of this hard to believe. As a matter of fact, I don't believe it. All of the "adults", the "serious" people told us that "free" trade, runaway trade deficits, manufacturing decline, explosive growth in debt and financial sector profits, asset bubbles, stagnant or declining incomes, ever rising inequality, Open Borders, etc. would make us all rich.

It didn't work out that way? I am shocked, shocked. Thomas Friedman is showing up as the false prophet of our age.

[dd]

The SEC and the CFTC are a secondary players that have continually been outmaneuvered by the Fed on the OTC derivatives issue. The SEC was merely codifying the practice over which it had no control because IBs were deep into derivatives, a "private" and opaque market that has always had full support of a Fed that obstructed any attempt to regulate:
"I am pleased to be here today to present the Federal Reserve Board's views on the regulation of over-the-counter (OTC) derivatives. Under Secretary Hawke has already addressed the specific questions raised in your letter of invitation. The Board generally agrees with the Treasury Department's views on these issues. In particular, the Board supports a standstill of attempts by the Commodity Futures Trading Commission (CFTC) to impose new regulations on OTC derivatives as a minimalist approach to our longstanding concerns about CFTC assertions of authority in this area.1 In my testimony I shall step back from these issues of immediate concern and address the fundamental underlying issue, that is, whether it is appropriate to apply the Commodity Exchange Act (CEA) to over-the-counter derivatives (and, indeed, to financial derivatives generally) in order to achieve the CEA's objectives--deterring market manipulation and protecting investors."
snip
"The primary source of regulatory effectiveness has always been private traders being knowledgeable of their counterparties. Government regulation can only act as a backup. It should be careful to create net benefits to markets."
Testimony of Chairman Alan Greenspan
The regulation of OTC derivatives
Before the Committee on Banking and Financial Services, U.S. House of Representatives
July 24, 1998
http://www.federalreserve.gov/BOARDDOCS/TESTIMONY/1998/19980724.htm

[bob mcmanus]

Essentially, while the decline will continue for some while, we have already undone the remarkable economic gains of the Clinton years. ...Anne

Economists have really had only one job, one responsibility since the 1920s.

That reponsibility was never really growth. Thirty years of growth can be wiped out in a year, or even a day.

Milton Friedman ate the heart of the science.

[OhNoNotAgain]

"I never would have imagined this was possible, and do not really understand how it could be so since the Bush expansion was continually weaker than makes sense to me in terms of domestic conditions and in terms of a wonderfully growing international economy."

It's the difference between an economy growing from the bottom up in real wages and income vs. an economy growing only at the top, while the rest use debt to finance the difference. The former is what we had after WWII, and the latter is what we had during the Bush administration and in the 1920's.

[anne]

http://www.nytimes.com/2008/10/04/business/04bank.html?ref=business&pagewanted=print

October 4, 2008

Wells Fargo in a Deal to Buy All of Wachovia
By ERIC DASH

In a surprise twist, the West Coast bank Wells Fargo & Company, said Friday that it had reached an agreement to acquire a rival, the Wachovia Corporation, for about $15.1 billion in stock.

The announcement came just four days after Citigroup had agreed to buy Wachovia's banking operations for $2.2 billion, or about $1 a share in a deal brokered by the Federal Deposit Insurance Corporation.

But Wachovia, which is based in Charlotte, N.C., has now apparently rejected that deal in favor of one where the entire company would be acquired....

[anne]

Warren Buffett, Berkshire Hathaway, controls 9.4% of Wells Fargo, which has come through the financial crisis strong at every point. So we have Berkshire taking significant interests in Goldman Sachs, GE and Wachovia at highly attractive prices. Such is what having reserves and patience is about in investing.

Wow.

[anne]

"It's the difference between an economy growing from the bottom up in real wages and income vs. an economy growing only at the top...."

The question is still, why should this have been so? Warren Buffett in 1999, wrote that the share of national income going to ordinary workers was as low as recorded and would not go any lower, but Buffett was decidedly wrong in ways I do not understand and expect he does not understand.

[OhNoNotAgain]

"Such is what having reserves and patience is about in investing."

Indeed. Keep your head down, make modest profits, and wait until someone else screws the pooch. What's amazing is how often it works, yet not many practice it.

[Doug]

BTW, for all those touting those 96 months of Clinton - you are praising THAT bubble because it's convenient to do so. Partisan hacks.

I hope reasonable liberals would agree with me on that.

[Jennifer]

I am not an economist. I am one of those "MAIN STREET" people, although my street is actually named Spyglass, which is a far cooler address. My husband is a veterinarian and owns multiple practices. So far, we have not had a credit problem, although he wrings his hands a lot, worrying about whether the bank will cut our line of credit. I expect it will hit Birmingham soon though, since Wachovia is a major player in our banking industry here.
I like reading this blog even though I have absolutely NO IDEA what half of it means. It makes me feel informed!!

[anne]

Through the 96 months of the Clinton Presidency, there were an average of 225,000 jobs created a month, with rising wages and benefits for ordinary workers, with minimal inflation, high domestic investment, high productivity growth, a budget deficit that continually declined and turned to an important surplus and with a strong dollar.

The Clinton economy was superb.

[Doug]

anne - it was all built on speculative bubbles. For you to deny it makes you a Clinton hack.

[anne]

Jennifer:

"My husband is a veterinarian and owns multiple practices. So far, we have not had a credit problem, although he wrings his hands a lot, worrying about whether the bank will cut our line of credit. I expect it will hit Birmingham soon though, since Wachovia is a major player in our banking industry here.

Wells Fargo has bought all of Wachovia, rather than just the banking operations, and Wells has ample reserves, which is highly promising for credit flows.

[anne]

"It was all built on speculative bubbles. For you to deny it makes you a Clinton hack. For you to deny it makes you a Clinton hack."

Simply notice the rottenness of the language, not to mention the idiocy.

[Jesse]

The current level of corruption is so pervasive that I wonder if this bailout plan is going to be like UN aid to a third world country where the warlords take it and use it for their own purposes allowing a trickle to reach the intended victims.

http://tinyurl.com/4p2ohh

[anne]

http://www.epi.org/printer.cfm?id=3127&content_type=1&nice_name=webfeatures_econindicators_jobspict_20081003

October 3, 2008

Jobs Decline for Ninth Month in a Row as Labor Market Recession Deepens
By Jared Bernstein and Heidi Shierholz, with research assistance from Tobin Marcus

We interrupt the financial meltdown to remind you that the nation’s payrolls have been contracting for nine months in a row.

The nation's employers continue to cut payrolls, with jobs down by 159,000 in September, the ninth consecutive month of job losses according to today's report from the Bureau of Labor Statistics.

Unemployment was unchanged over the month, as an increase in the number of the jobless (up 101,000) was offset by a decline in the labor force (down 121,000). The underemployment rate, a more comprehensive measure of job-market slack, jumped to 11%, the highest level since in over 14 years. As of last month, one in nine persons is either unemployed or underemployed.

So far this year, payrolls are down 760,000 overall and 969,000 in the private sector (the latter loss began in December). Unemployment, at 6.1%, is up 1.4 points over the past year, while underemployment is up 2.6 points. Over the past year, the unemployment rolls have expanded by 2.2 million, to 9.5 million, the highest number of unemployed since December of 1992.

While the overall unemployment rate was unchanged last month, African American unemployment rose from 10.6% to 11.4%, driven by an increase among black men from 11.2% in August to 12.9% in September (the rate for black men is more than twice that of white men (5.9%)). As is often the case in a recession, black joblessness is rising much more quickly than that of the overall workforce. Since June, black unemployment has jumped 2.2 percentage points, from 9.2% to 11.4%, compared to a 0.6 point increase in the overall rate.

Two serious problems in today’s job market are 1.) the lack of job creation, along with increased layoffs, means that job seekers are stuck in unemployment and unable to find work, and 2.) over 6 million workers who have kept their jobs are unable to find their desired hours of work.

The first problem—extended unemployment spells, as measured by the share of unemployed who have been jobless for at least six months—increased to 21.1% in September, the highest long-term share since March of 2005. The fact that so many workers are stuck on the jobless rolls calls for an immediate policy response to help them, as discussed below. The fact that Congress is about to vote on a $700 billion package to bailout Wall St. makes this policy response to directly help Main St. that much more important.

The second problem—involuntary part-time work—is evident in the increase in the number of persons working part-time who would prefer full-time work, up over 300,000 since last month and 1.6 million over the past year. Over 6 million workers were involuntary part-timers last month, the highest number since December 1993.

The loss of jobs and hours is also reflected in slower weekly wage growth. Weekly earnings for most workers, before accounting for inflation, rose 2.8% over the past year—September 2007-September 2008—well below recent inflationary readings. In other words, paychecks continue to lag behind prices, contributing to the squeeze on working families.

Job losses occurred across most industries. Factory jobs were down by 51,000 last month, led by declines in autos and auto parts. Persistent losses in the factory sector—this is the 27th consecutive month of job losses—show no signs that the recent improvement in the U.S. trade balance has led to either gains or even slower losses in manufacturing employment.

Service employment was also down, as private services (excluding government) shed 91,000 jobs in September. Likely reflecting weak consumer spending in the third quarter of this year, retail trade employment was down 40,100, with large losses in auto dealerships (down 8,600) and department stores (down 10,800).

Financial services, beset by the implosion of the real estate bubble and the credit crunch, shed 17,000 jobs last month and 110,000 over the past year.

Only health care and government continue to reliably generate job growth (and given the large government presence in health care markets, these two sectors are related). Over the course of this year, while overall payrolls have shed more than three-quarters of a million jobs, health care employment is up by 269,000.

Once a year, the Bureau of Labor Statistics revises the establishment data to reflect a more accurate count of the number of jobs in the labor market. The preliminary estimate of this benchmark, announced today, was a small downward revision of 21,000. This means that as of March 2008, there were an estimated 21,000 fewer jobs than previously reported. Preliminary estimates for the private sector indicate a larger downward revision of 81,000. If these preliminary estimates hold, it will mean that private sector employment has declined by over 1 million jobs since November of 2007....

[Invisible Hand]

Even though this deal is incredibly dumb, I too hope it will pass. For one thing, I figure that there is a 5% possibility that it might actually work, and avert a major recession.
More importantly, if the bill doesn't pass then Paulsen and the Banksters will blame Congress, rather than themselves, when the Dow drops and the recession bites. Their propaganda machine has breathtakingly effective. This way, when the $700 billion bailout plan passes and flops, they will be exposed as the charlatans and incompetents they are.

[don]

Easy Money:
Mises was right. We are taking the latter course, and the result will be much worse than if we took the former. The time rate of dicount is understandably low for the political 'leadership.' Krugman and his ilk have no such excuse.

[donna]

Only Obama's team is ready to hit the ground running. Reason enough to vote for him right there, and the main reason I support Obama IS his economic team.

[Hal]

kotza: I think the required point about linking the Iraq lies to what Bush says about the economy is that since he revealed himself as a liar he has had no standing to be believed when he wasn't, for a rare change, lying. Liars ruin their reputation. Bush ruined his so that whatever truths he spoke afterward would be immediately questioned and discounted.

[Lafayette]

anne: LIBOR is London interbank offered rate

Now, yes.

But it used to be the London Inter Bank Overnight Rate, for lending literally overnight in order to close the books daily.

[Lafayette]

anne: The Clinton economy was superb.

Huh? Ever heard of the Glass-Steagal Act?

So, pray tell how its demise had Nothing Whatsoever to do with the subprime chaos.

[anne]

Though I would prefer to have the Glass-Steagall Act, I have noticed nothing about the financial crisis that suggests repeal of the act has contributed to the financial crisis. Passage of the repeal by the way was opposed by every Democrat in the Senate save for Fritz Hollings, but the legislation was signed by President Clinton.

[rufus]

Anne,
"Though I would prefer to have the Glass-Steagall Act, I have noticed nothing about the financial crisis that suggests repeal of the act has contributed to the financial crisis."

http://thomas.loc.gov/cgi-bin/bdquery/z?d106:SN00900:@@@D&summ2=m&

"Gramm-Leach-Bliley Act - Title I: Facilitating Affiliation Among Banks, Securities Firms, and Insurance Companies - Subtitle A: Affiliations - Amends the Banking Act of 1933 (Glass-Steagall Act) to repeal prohibitions: (1) against affiliation of any Federal Reserve member bank with an entity engaged principally in securities activities (securities affiliate); and (2) against simultaneous service by any officer, director, or employee of a securities firm as an officer, director, or employee of any member bank (interlocking directorates)."

"to repeal prohibitions: (1) against affiliation of any Federal Reserve member bank with an entity engaged principally in securities activities (securities affiliate)"

This simplistic statement in the CRS Summary gives some explaination how a securities crisis has become a banking crisis.

The CRS Summary linked above and the full text of the bill should explain the rest.

[Doug]

Simply notice the rottenness of the language, not to mention the idiocy.

Posted by: anne | Link to comment | October 03, 2008 at 10:19 AM

So evade the issue once again. Clinton presided over a bubble economy.

[anne]

I find no link from repeal of the Glass-Steagall Act to the current financial crisis.

The economic gains through the Clinton years were indeed real and important, but have been completely undone through the Bush years.

[rufus]

More Awful Truths About Republicans
Daily Article by Robert B. Ekelund and Mark Thornton | Posted on 9/4/2008

http://mises.org/story/3098

"...But an insidious form of "market-based policy" is also a real culprit in the current mess. In 1999 a bill was passed by a Republican Congress and signed by Democratic President Bill Clinton that rescinded the Depression era's divorce of commercial banking activities from investment banking, called the Glass-Stegall Act of 1933. That opened a floodgate of "creative" financial instruments backed by notes and other commercial paper. Much of the banking regulation of the Roosevelt administration — including abandonment of the gold standard — made absolutely no sense, but markets can fail with dire short-run consequences under a fiat monetary system. With Glass-Stegall, Congress put its finger on and mitigated the tendency and temptations of banks to create massive costly externalities to society, in this case, by holding bundled mortgage-backed securities which were deemed safe by rating agencies but which ultimately failed the market test.

The Financial Services Modernization Act of 1999 would make perfect sense in a world regulated by a gold standard, 100% reserve banking, and no FDIC deposit insurance; but in the world as it is, this "deregulation" amounts to corporate welfare for financial institutions and a moral hazard that will make taxpayers pay dearly. Such government privileges are nothing new to Republicans — consider the effective subsidies to the pharmaceutical, sugar, and steel industries — but this particular gift to financial institutions is what allowed the credit bubble to expand to such absurd proportions, because it allowed banks of all types to engage in increasingly risky transactions and to greatly expand the leverage of their balance sheets. As the crisis unfolds, credit continues to contract, the risk of bank failures increases, and the possibility of far more serious economic consequences become more apparent. The S&L crisis cost the taxpayers a few hundred billion, but this crisis has the potential of saddling the taxpayer with several trillion in bailouts..."

[rufus]

Vice Chairman Donald L. Kohn
At the Brookings Panel on Economic Activity, Washington, D.C.
September 11, 2008

Comments on “Financial Regulation in a System Context,” “Beyond Leveraged Losses: The Balance Sheet Effects of the Home Price Downturn,” and “The Central Role of House Prices in the Financial Crisis: How Will the Market Clear?”

http://www.federalreserve.gov/newsevents/
speech/kohn20080911a.htm

"I appreciate the opportunity to comment on these three papers.1 They illuminate the sources and effects of the current financial market turmoil, and I learned a considerable amount from reading them and thinking about their implications. Instead of providing detailed comments on each paper, I'd like to draw out the relationships among them and, in the process, comment a little on the papers and their implications. To foreshadow: I will be highlighting the role of leverage--in the household sector and in financial intermediaries--as a critical factor in understanding the buildup of excesses and their unwinding.

At the beginning of the chain of causation is the housing cycle in the United States. Chip Case points out the difference between this housing cycle and others over past decades and asks why the difference developed. One culprit he identifies is changes in the financial system that affected the way that mortgage credit is made available to borrowers. A key element of these changes, and one that accounts for a good part of the subsequent effects of the financial system and the economy, is the rise in leverage in housing finance. As Case notes, for several years, mortgage indebtedness rose substantially relative to the value of owner-occupied housing. The willingness of lenders to tolerate--or, in some cases, encourage--huge increases in loan-to-value ratios added to the demand for housing, especially by people who normally might not have had the savings to enter the market, and contributed to the rise in home prices.

One reason for the loosening of standards was the expectation that house prices would continue to rise--and even more certainly that they could not fall in all regions at the same time, supporting diversification through securitization. Rising prices would enable lenders to recoup their funds even if the borrower was unable to service the loan, mostly because the borrower would be able to obtain extra cash through refinancing. Expectations of house price appreciation facilitated and interacted with the increasing complexity of mortgage securities, including multiple securitizations of the same loan, which made it virtually impossible for ultimate lenders to monitor the creditworthiness of borrowers--a task they, in effect, had outsourced to credit rating agencies. The absence of investor caution and due diligence was especially noticeable for the highest-rated tranches of securitized debt.

Elevated leverage in housing markets has meant that as prices have fallen, lenders have had to absorb an unusually high proportion of the losses. As Case points out, foreclosures by lenders have added to the downward pressure on those prices. Conceptually, such price declines moving down the demand curve for housing services could accelerate and cushion the adjustment in activity necessitated by previous overbuilding. I am encouraged that Case finds the pace of declines abating in a number of markets. However, partly owing to the feedback of price declines on lenders, mortgage conditions have tightened some since the late spring readings he is using for his conclusion, and in my view, the jury is still out on whether housing prices are close to finding a bottom.

The heavy involvement of financial intermediaries in amplifying the housing boom and the subsequent economic effects of the bust brings me to the Morris and Shin paper, which raises a host of important issues related to the systemic aspects of financial intermediation and the lessons from the recent turmoil. As they emphasize, one of the important lessons has been the greater-than-expected vulnerability of secured financing when intermediaries are engaged in maturity, credit, and liquidity transformation. Recall that the turmoil first came onto the balance sheets of the banks through the collapse of the asset-backed commercial paper market last fall before it affected the funding of investment banks through the triparty repurchase agreement market. The new vulnerability results importantly from the extension of secured short-term financing to increasingly illiquid and riskier long-term assets. As uncertainty about the liquidity and creditworthiness of those assets--especially related to mortgage-backed securities--was called into question, lenders became more concerned about the possibility that they might end up owning the underlying assets, and they raised haircuts or simply refused to roll over loans.

Clearly, as Morris and Shin point out, what we have learned about various risks implies the need for intermediaries to build greater liquidity and capital buffers in good times, as well as to improve their abilities to manage their risks. And those larger buffers would help to offset the moral hazard that may have been created through the expansion of our liquidity facilities. Getting the micro-prudential piece right--having each institution adequately protected--would go a long way toward making the whole system more robust and resilient.

But Morris and Shin would go further; they would impose additional requirements on institutions to take account of the externalities for the system created when common shocks impair markets and credit availability by provoking widespread actions to preserve shareholder value. They would do this through a higher liquidity requirement and through the imposition of a leverage ratio on investment banks, which is already in place for commercial banks.

I agree with the authors, and with Chairman Bernanke, that we need to consider the level of buffers that is appropriate to ameliorate systemic risk. That said, a host of difficult judgments are inherent in how we establish such a system, and I'll raise just a few on a very general level. One set concerns the size of the buffers. How far into the tail should intermediaries be required to insure themselves? Shouldn't the Federal Reserve take some of the liquidity tail risk to facilitate intermediation of illiquid credits, as was intended at our founding? Moreover, the larger the regulatory tax, the more likely it is that activity will migrate to unregulated sectors in an environment of fluid and free capital movements. How can we gain better assurance of systemic stability when we are unlikely to be able to continuously extend the reach of regulation, and will it be sufficient to deepen the moats around the core institutions? In this regard, the leverage ratio gives incentives to move some activities away from regulated institutions.

A second question is, How we can structure these requirements and other aspects of regulation to damp, rather than reinforce, the natural procyclical tendencies of the financial system? Among the challenges will be encouraging firms and supervisors to comfortably allow buffers to be eroded in bad times. Interestingly, prompt corrective action under the Federal Deposit Insurance Corporation Improvement Act of 1991 was intended, in part, to induce an element of countercyclical behavior by banks. It gives banks an incentive to build excess capital--on both a risk-based and leverage ratio basis--in good times to avoid prompt corrective action when circumstances are less favorable. Now that we are in the latter state of the world, a study of how commercial banks are viewing capital ratios, including the leverage ratio, could inform consideration of the Morris and Shin proposal.

The Morris and Shin paper also provides a framework for thinking about the Federal Reserve's credit facilities. On page 9, they note that liquidity makes borrowers feel more robust and lenders less likely to withdraw, raising the odds for a more stable equilibrium for the entire system. That is exactly what we have been trying to do with our various discount lending facilities. The assurance of the availability of liquidity to sound institutions against good collateral should counter the greater uncertainty and risk aversion that have impaired normal arbitrage and intermediary functions by making those institutions more willing to extend credit and take positions in the process of making markets. It should also assure other creditors of those institutions that illiquid markets will not impede the repayment of their loans, and therefore make them more willing to keep lending. A number of markets remain disrupted and illiquid. But I believe that they would have been even more illiquid and the risk of disruptive runs even greater without our various facilities; that's certainly what market participants are telling us.

Jan Hatzius is trying to gauge the combined effects on spending of the losses generated by the effects of the decline in housing prices outlined in the Case paper and the impulse for deleveraging in the financial sector inherent in the processes discussed by Morris and Shin. To restore capital ratios depleted by mortgage losses and to raise those ratios even further in order to reduce leverage to safer levels demanded by counterparties, banks and other lenders need to reduce assets. They do so by tightening terms and standards across a broad array of credit--and we have seen this behavior reflected in our surveys of bank lending officers and in various spreads and other measures of risk perceptions, risk aversion, and reduced supply of credit at benchmark interest rates. In the current circumstances, some of the tightening we have seen has been in anticipation of possible adverse events in the economy and in confidence toward the financial sector. These types of actions not only move up the demand-for-credit curve, but they also bolster profits going forward to cover potential write-offs and to attract new equity capital. Pressures on profits arise not only from write-offs, but also because some sources of earnings, like securitization of mortgages or leveraged loans, are no longer available.

In the steady state, lenders will get greater returns for taking risk than they did two years ago, intermediaries will be less leveraged and better capitalized, and the financial system will be more robust and resilient to shocks. The transition to the new steady state, however, as lenders deleverage and protect themselves against various downside risks, involves some overshooting--making terms and standards tighter than will be necessary over the long run.

This story is completely consistent with the one told in the Hatzius paper, which relies mostly on quantity relationships to gauge the possible effects on gross domestic product (GDP). My instinct has been to go from the actual and expected indicators of tightening supply, such as the instrumental variables used in the paper, directly to estimates of the effects of that supply shift on GDP. Measures of flows would fall out of that exercise, but not be its focus. And I have questions about the stability and reliability of the debt-GDP relationship used in the forecasts at the end of the paper. But I will admit that we are in uncharted waters here, and the navigators shouldn't discard any potential information about the location of the shoals.

The message of the paper is that restraint on credit supplies is likely to persist because intermediaries have some way to go to rebuild their balance sheets. The process of adjustment to a safer, more resilient financial system is going to take a while. I agree with this observation."

I would have referenced Bernanke's recent speech on systemic risk, but it was even longer and riddled with even more 'Greenspan Speak'.

[dd]

"I find no link from repeal of the Glass-Steagall Act to the current financial crisis."

I find many links the first of which is a confusion among regulators as to the ability to regulate and how regulation ought be accomplished among the many oversight bodies. Hence your post above about the supposed SEC gaffe but more to the point an agency stripped of real oversight in the holding companies but still responsible for broker dealers subsidiaries. Absurd and more absurd and that was the point of Gramm Leach to confuse, confound and tie in knots the regulators trying to discern their jurisdiction. It was deliberate obfuscation and meant to undermine FDR's carefully crafted distinctions built on the testimony of those responsible for the 1929 collapse.

[dd]

Here is the PBS chronology on the demise of Glass-Steagall. Notice the Fed's insistent role and notice too Citibank's insistent violations of law that are happily amended under Clinton to retrospectively make legal the illegal:
http://www.pbs.org/wgbh/pages/frontline/shows/wallstreet/weill/demise.html

[dd]

As for the economic gains under Clinton, as distinguished from his abysmal regulatory stance, there were real gains and he promoted the computer revolution but was perhaps by lack of experience with Wall Street complicit in the demise of the many fine protections FDR afforded everyday citizens who will suffer far more than the Rubin's of the world.

[paine]

"A solution ... will ... almost surely involve the U.S. government taking partial, temporary ownership of [the financial] system"

feckless wording

"...partial ,temporary ...."

why ???

let us restore the temple
let us renew the system

bull shit

uncle take it and keep it

like health insurance
the systm only needs
one ultimo lender
no matter how it de centralizes itself
creates its own league of contesting funds
first and last resort uncle's credit
is the source
the rock so ...anyway ...eh ??

[paine]

clinton bush
bush clinton

the present debacle was bi partisan
to its yellow toe nails

[dd]

paine, as always
cuts to the chase

[dd]

but must ask if
it matters which
of uncles many disguises
runs the central gig
or is democracy
just a current fad

[Lafayette]

anne: Passage of the repeal by the way was opposed by every Democrat in the Senate save for Fritz Hollings, but the legislation was signed by President Clinton.

Oh, I see ... so you are intimating that the Dems cannot be collectively wrong? Robert Rubin will be soooo pleased to hear that. Frankly - I didn't know that was an attribute of the Democrat Party. Do they walk on water as well? Just asking ...

Had the Glass-Steagal Act remained, it would have been doubtful that the business models for Risk Aversion (commercial banking) and Risk Management (investment banking) would be confused.

AIG is a prime example. It was brought down by a tiny, tiny derivatives department that, actually, added zilch to the company's bottom line.