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Best Financial Quotes of 2007
- Thread starter drillinto
- Start date
The Times, London, UK
November 8, 2007
Hey, Guv, can you spare us £30 billion quid?
Anatole Kaletsky: Central banks must stand firm against pressure from financiers
Should tens of billions of pounds of public money be diverted from health, education, defence and other social services to underwrite the profits of hedge funds, protect the jobs of international bankers and subsidise stockbrokers' bonuses?
This is effectively what “government sources” suggested two months ago when they criticised the Bank of England for failing to offer a line of credit to support a takeover of Northern Rock by Lloyds TSB. At the time, the suggestion that bankers were more deserving of public subsidies than coalminers or car workers seemed so preposterous, especially from a Labour Government, that nobody paid much attention to the whispering campaign about the Northern Rock bail-out. It was assumed that government spin-doctors were trying to deflect blame to any available scapegoat.
Pointing to the Bank of England's refusal to finance a Northern Rock takeover was temporarily more convenient than publicly admitting that the management of the Rock had destroyed what was once a good business and the company would have to be wound up.
Yesterday morning it appeared, however, that Alistair Darling and Gordon Brown might actually be contemplating a plan to spend billions of pounds on subsidies to the managers and investors in this dying bank. Is it possible that ministers are now so worried about the few thousand job losses in Newcastle that would follow from the orderly liquidation of Northern Rock that they would seriously consider supporting a “private sector” takeover with tens of billions of pounds of public money?
This seems the only logical explanation for the reports of dismay at the Treasury about Mervyn King's “naive” BBC interview, in which the Bank of England Governor confirmed the grim calculations about Northern Rock's financial requirements. The Governor explained that the Treasury and the Bank of England had jointly rejected offers to “buy” Northern Rock, thereby averting the embarrassing bank-run, because all such “white knight” rescues would have demanded up to £30 billion in public funding to make the figures add up.
Why should the Government have offered such an immense sum to subsidise a bid from one bank for another? Why, in fact, should the Government have even considered such funding?
“Banks have to take the consequences of the risks that they undertake,” said the Governor. “That is what happens in any other industry. It is not the role of the central bank to bail out people who takes unnecessary risks, in just the same way as the Government doesn't bail out manufacturing companies that take risks and their product fails. I was asked whether if a certain retail high street bank were to make an offer or a bid for Northern Rock whether we would be prepared to lend that bank £30 billion, at the bank rate, for about two years. So I said this is a matter for government.”
One would have imagined gratitude at the Treasury for these comments. The Governor had confirmed and endorsed the Chancellor's wisdom in refusing to spend a staggering sum of public money to subsidise a private bank. But instead of thanking the Governor, “Treasury sources” busied themselves on Tuesday rubbishing his comments and implying that the failure of a private “rescue” for Northern Rock reflected the Bank's unworldly delicacy about the “moral hazard” of subsidising imprudent private banks.
This is an astonishing reversal. The Bank of England, traditionally regarded as the representative of City interests in the British governmental Establishment, is calling for consistency of treatment between industrial workers and bankers. Meanwhile, a Labour Chancellor is apparently embarrassed to admit that he has rejected a demand for ransom to the tune of £30 billion from City bankers, a payment that would probably have constituted the biggest government support package offered to a private company in any market economy.
What, then, is going on? The answer is fairly clear. Around the world, banks, insurance companies and hedge funds have landed themselves in trouble because of a series of miscalculations, involving not just the US sub-prime market but also the way that mortgage banks, hedge funds and private equity houses have been financed. These miscalculations were ignored for many years because they were so profitable. But now part of the excess profits earned by the global financial industries has to be written off. As a result, investors are seeing the share prices of financial companies tumble, hedge-fund managers are seeing their bonuses jeopardised and some senior bankers are being forcibly ejected, albeit with golden parachutes of up to $150 million.
The financiers are responding to this shake-out by putting enormous pressure on governments and central bankers on both sides of the Atlantic to reverse, or at least arrest, these costly and embarrassing trends ”” first and foremost, by cutting interest rates aggressively, even at a time when global economic growth is booming and inflation is still looming; secondly, by supporting financial institutions with public intervention, as in the case of Northern Rock or Germany's Sachsen Landesbank or the US Treasury's proposal for Wall Street to mount a bailout for the mortgage vehicles created by Citibank.
The wonder of financial markets is that they can exert such political pressures without any conscious conspiracy on the part of the bankers. They do this by creating an atmosphere of crisis based on exaggerated interpretations of relatively minor movements in shares and currencies. While the US and British economies grow strongly, and most industries, apart from finance and housebuilding, continue to do well, economists prophesy darkly about the chances of a catastrophic global impact from the credit crunch. While global stock market averages have fallen by less than 5 per cent from the summer's record highs, City and Wall Street analysts call for emergency interest rate cuts to shore up the tumbling share prices of leading international banks.
It is of paramount importance that the Bank of England and the US Federal Reserve Board ignore such calls. An article of faith of modern economic policy is that central banks must be independent of politicians. It is infinitely more important that they should be independent of bankers and financiers. As Mr King said in his interview: “The role of the Bank of England is not to do what banks ask us to do; it is to do what is in the interest of the country as a whole.”
The job of the central banks is to manage demand and stabilise inflation and unemployment. If central banks start to follow the markets instead of leading them, then all the gains achieved by the flexible monetary policy of the past two decades will be jeopardised.
November 8, 2007
Hey, Guv, can you spare us £30 billion quid?
Anatole Kaletsky: Central banks must stand firm against pressure from financiers
Should tens of billions of pounds of public money be diverted from health, education, defence and other social services to underwrite the profits of hedge funds, protect the jobs of international bankers and subsidise stockbrokers' bonuses?
This is effectively what “government sources” suggested two months ago when they criticised the Bank of England for failing to offer a line of credit to support a takeover of Northern Rock by Lloyds TSB. At the time, the suggestion that bankers were more deserving of public subsidies than coalminers or car workers seemed so preposterous, especially from a Labour Government, that nobody paid much attention to the whispering campaign about the Northern Rock bail-out. It was assumed that government spin-doctors were trying to deflect blame to any available scapegoat.
Pointing to the Bank of England's refusal to finance a Northern Rock takeover was temporarily more convenient than publicly admitting that the management of the Rock had destroyed what was once a good business and the company would have to be wound up.
Yesterday morning it appeared, however, that Alistair Darling and Gordon Brown might actually be contemplating a plan to spend billions of pounds on subsidies to the managers and investors in this dying bank. Is it possible that ministers are now so worried about the few thousand job losses in Newcastle that would follow from the orderly liquidation of Northern Rock that they would seriously consider supporting a “private sector” takeover with tens of billions of pounds of public money?
This seems the only logical explanation for the reports of dismay at the Treasury about Mervyn King's “naive” BBC interview, in which the Bank of England Governor confirmed the grim calculations about Northern Rock's financial requirements. The Governor explained that the Treasury and the Bank of England had jointly rejected offers to “buy” Northern Rock, thereby averting the embarrassing bank-run, because all such “white knight” rescues would have demanded up to £30 billion in public funding to make the figures add up.
Why should the Government have offered such an immense sum to subsidise a bid from one bank for another? Why, in fact, should the Government have even considered such funding?
“Banks have to take the consequences of the risks that they undertake,” said the Governor. “That is what happens in any other industry. It is not the role of the central bank to bail out people who takes unnecessary risks, in just the same way as the Government doesn't bail out manufacturing companies that take risks and their product fails. I was asked whether if a certain retail high street bank were to make an offer or a bid for Northern Rock whether we would be prepared to lend that bank £30 billion, at the bank rate, for about two years. So I said this is a matter for government.”
One would have imagined gratitude at the Treasury for these comments. The Governor had confirmed and endorsed the Chancellor's wisdom in refusing to spend a staggering sum of public money to subsidise a private bank. But instead of thanking the Governor, “Treasury sources” busied themselves on Tuesday rubbishing his comments and implying that the failure of a private “rescue” for Northern Rock reflected the Bank's unworldly delicacy about the “moral hazard” of subsidising imprudent private banks.
This is an astonishing reversal. The Bank of England, traditionally regarded as the representative of City interests in the British governmental Establishment, is calling for consistency of treatment between industrial workers and bankers. Meanwhile, a Labour Chancellor is apparently embarrassed to admit that he has rejected a demand for ransom to the tune of £30 billion from City bankers, a payment that would probably have constituted the biggest government support package offered to a private company in any market economy.
What, then, is going on? The answer is fairly clear. Around the world, banks, insurance companies and hedge funds have landed themselves in trouble because of a series of miscalculations, involving not just the US sub-prime market but also the way that mortgage banks, hedge funds and private equity houses have been financed. These miscalculations were ignored for many years because they were so profitable. But now part of the excess profits earned by the global financial industries has to be written off. As a result, investors are seeing the share prices of financial companies tumble, hedge-fund managers are seeing their bonuses jeopardised and some senior bankers are being forcibly ejected, albeit with golden parachutes of up to $150 million.
The financiers are responding to this shake-out by putting enormous pressure on governments and central bankers on both sides of the Atlantic to reverse, or at least arrest, these costly and embarrassing trends ”” first and foremost, by cutting interest rates aggressively, even at a time when global economic growth is booming and inflation is still looming; secondly, by supporting financial institutions with public intervention, as in the case of Northern Rock or Germany's Sachsen Landesbank or the US Treasury's proposal for Wall Street to mount a bailout for the mortgage vehicles created by Citibank.
The wonder of financial markets is that they can exert such political pressures without any conscious conspiracy on the part of the bankers. They do this by creating an atmosphere of crisis based on exaggerated interpretations of relatively minor movements in shares and currencies. While the US and British economies grow strongly, and most industries, apart from finance and housebuilding, continue to do well, economists prophesy darkly about the chances of a catastrophic global impact from the credit crunch. While global stock market averages have fallen by less than 5 per cent from the summer's record highs, City and Wall Street analysts call for emergency interest rate cuts to shore up the tumbling share prices of leading international banks.
It is of paramount importance that the Bank of England and the US Federal Reserve Board ignore such calls. An article of faith of modern economic policy is that central banks must be independent of politicians. It is infinitely more important that they should be independent of bankers and financiers. As Mr King said in his interview: “The role of the Bank of England is not to do what banks ask us to do; it is to do what is in the interest of the country as a whole.”
The job of the central banks is to manage demand and stabilise inflation and unemployment. If central banks start to follow the markets instead of leading them, then all the gains achieved by the flexible monetary policy of the past two decades will be jeopardised.
Op-ed in defense of the supply-side. It is a must-read.
*************
The Supply-Side Solution
If tax-cut strategies don't work, why are they so popular abroad?
BY STEPHEN MOORE | Wall Street Journal | Friday, November 9, 2007
I recently spoke with Mart Laar, the former prime minister of Estonia and the godfather of that nation's flat tax. The major opposition to his tax reform, he explained, was not the citizenry; rather it came from the economists and the other Wise Men of government.
"I was told, 'We cannot do a flat tax. It is untested. It will not work. It will cause budget deficits," Mr. Laar recalls. However, he believed it would work because of what he'd read about it in Milton Friedman's classic, "Free to Choose." And so, in 1994, Mr. Laar ignored the economic pundits and snapped into place a 23% flat tax. Estonia has since experienced one of the most rapid growth spurts of any nation in the world.
There's a lesson here for our country: Revolutionary ideas in economics, especially if they don't leverage the power of the state, are often resisted by the intellectual elite. Ronald Reagan discovered this in 1980 when he was ridiculed by the establishment for proposing cuts in marginal tax rates as a cure for the high inflation and economic malaise of the 1970s.
Gardner Ackley, a former chairman of the Council of Economic Advisers, famously told Congress that it would be "a miracle" if the tax cuts worked to reduce inflation and increased growth. But reduced inflation (with an assist from Fed Chairman Paul Volcker) and increased growth is what happened in the 1980s.
Here we are 27 years later--with 40 million more jobs and a nearly $50 trillion higher net worth--yet the left intelligentsia is still obsessed with discrediting supply-side economics. In recent weeks, the New York Times, the New Yorker, the New Republic and many other liberal publications have devoted great space and attention to attacking the entire theory that lower tax rates can increase incentives for investment, saving and work.
The original champions of these ideas, men such as Arthur Laffer and George Gilder, are not just misguided, they are, according to the New Republic, "deranged," "crackpots," and even "possibly insane." James Surowiecki complains in the New Yorker that supply-side tax prescriptions for the economy are the equivalent of "saying that the best way to treat sick people is to bleed them to let out the evil spirits."
The quality of this discourse rarely rises above the level of trash talk. Nevertheless, some arguments are repeated with such regularity that they need to be addressed. One is that supply-siders dishonestly claim that tax rate cuts increase tax revenues. Now, we can argue forever whether tax revenues would have been higher or lower without the Bush 2003 tax cuts. But one stubborn fact remains: Tax receipts are up, not down, by $745 billion in four years since the 2003 tax cuts.
It's one thing for the supply-side critics to have predicted four years ago that the Bush tax cuts would increase the budget deficit. But Mr. Surowiecki tells us, today, that "myriad studies" find that the Bush tax cuts "led to bigger budget deficits."
Bigger deficits? After the second Bush tax cut of 2003, the budget deficit tumbled to $163 billion in FY 2007 from $401 billion in FY 2003.
Supply-side economics is also denounced as a flim-flam whose sole purpose is to give jumbo-sized tax handouts to corporations and high-income earners. Since so many upper-income and wealthy Americans are Democrats, however, it's not clear why Republicans would be so preoccupied with helping them.
In any case, the share of taxes paid by the top 1% and 5% income earners has consistently risen from 1980 through 2007, even as tax rates declined. Today the highest income tax rate is half what it was in the 1970s. Yet the share of taxes paid by the top 1% of income earners is twice (39%) today what it was then (19%).
Regardless of what one believes about the distributional effects of the Reagan and Bush tax cuts, there's no expunging the reality that the economic growth rate surged after each of these changes--just as they did in the 1960s after President Kennedy's tax rate cuts. Robert Rubin and others reply that the economy boomed in the 1990s too, after Bill Clinton raised taxes. But supply-siders never argued that only tax cuts matter. Trade matters. Sound money matters. Regulations matter. In the 1990s, monetary, trade and spending policies were all leaning in a pro-growth direction, possibly offsetting the negative impact of the Clinton tax rate hikes.
What the critics have no plausible answer for is this: If the supply-side tax rate reduction model is truly so abhorrent, why are so many nations around the world latching on to it? What explains the Irish Miracle? Why are Germany, France and the U.K. slashing their corporate tax rates? Why are there 18 countries with flat taxes? Are their leaders deranged, or been bamboozled by crackpots? Perhaps a better explanation is that they know intuitively what a new National Bureau of Economic Research study has found: Nations with low tax rates on business have statistically significant higher rates of new business formation, investment and income.
History is clearly not on the side of the antisupply-side attack dogs, and they're losing the policy debate every day in political capitals around the world. Poland just announced it wants to implement a 15% flat tax by 2009. But the American left's obsession with the notion that tax rates don't matter tells us something important about the future. They are preparing the ground for massive tax increases if and when they capture control of the presidency.
I asked Rep. Paul Ryan of Wisconsin, a leading economic policy maker in the GOP, how many of the Democrats he works with buy into these screeds against supply-side economics. "Are you, kidding?" he replied. "Every one of the Democrats who sits in the front row of the Ways and Means Committee does. They've already got Charlie Rangel's tax increase baked into the cake."
Estonia, anyone?
[Mr. Moore is senior economics writer for the Wall Street Journal editorial board.]
*************
The Supply-Side Solution
If tax-cut strategies don't work, why are they so popular abroad?
BY STEPHEN MOORE | Wall Street Journal | Friday, November 9, 2007
I recently spoke with Mart Laar, the former prime minister of Estonia and the godfather of that nation's flat tax. The major opposition to his tax reform, he explained, was not the citizenry; rather it came from the economists and the other Wise Men of government.
"I was told, 'We cannot do a flat tax. It is untested. It will not work. It will cause budget deficits," Mr. Laar recalls. However, he believed it would work because of what he'd read about it in Milton Friedman's classic, "Free to Choose." And so, in 1994, Mr. Laar ignored the economic pundits and snapped into place a 23% flat tax. Estonia has since experienced one of the most rapid growth spurts of any nation in the world.
There's a lesson here for our country: Revolutionary ideas in economics, especially if they don't leverage the power of the state, are often resisted by the intellectual elite. Ronald Reagan discovered this in 1980 when he was ridiculed by the establishment for proposing cuts in marginal tax rates as a cure for the high inflation and economic malaise of the 1970s.
Gardner Ackley, a former chairman of the Council of Economic Advisers, famously told Congress that it would be "a miracle" if the tax cuts worked to reduce inflation and increased growth. But reduced inflation (with an assist from Fed Chairman Paul Volcker) and increased growth is what happened in the 1980s.
Here we are 27 years later--with 40 million more jobs and a nearly $50 trillion higher net worth--yet the left intelligentsia is still obsessed with discrediting supply-side economics. In recent weeks, the New York Times, the New Yorker, the New Republic and many other liberal publications have devoted great space and attention to attacking the entire theory that lower tax rates can increase incentives for investment, saving and work.
The original champions of these ideas, men such as Arthur Laffer and George Gilder, are not just misguided, they are, according to the New Republic, "deranged," "crackpots," and even "possibly insane." James Surowiecki complains in the New Yorker that supply-side tax prescriptions for the economy are the equivalent of "saying that the best way to treat sick people is to bleed them to let out the evil spirits."
The quality of this discourse rarely rises above the level of trash talk. Nevertheless, some arguments are repeated with such regularity that they need to be addressed. One is that supply-siders dishonestly claim that tax rate cuts increase tax revenues. Now, we can argue forever whether tax revenues would have been higher or lower without the Bush 2003 tax cuts. But one stubborn fact remains: Tax receipts are up, not down, by $745 billion in four years since the 2003 tax cuts.
It's one thing for the supply-side critics to have predicted four years ago that the Bush tax cuts would increase the budget deficit. But Mr. Surowiecki tells us, today, that "myriad studies" find that the Bush tax cuts "led to bigger budget deficits."
Bigger deficits? After the second Bush tax cut of 2003, the budget deficit tumbled to $163 billion in FY 2007 from $401 billion in FY 2003.
Supply-side economics is also denounced as a flim-flam whose sole purpose is to give jumbo-sized tax handouts to corporations and high-income earners. Since so many upper-income and wealthy Americans are Democrats, however, it's not clear why Republicans would be so preoccupied with helping them.
In any case, the share of taxes paid by the top 1% and 5% income earners has consistently risen from 1980 through 2007, even as tax rates declined. Today the highest income tax rate is half what it was in the 1970s. Yet the share of taxes paid by the top 1% of income earners is twice (39%) today what it was then (19%).
Regardless of what one believes about the distributional effects of the Reagan and Bush tax cuts, there's no expunging the reality that the economic growth rate surged after each of these changes--just as they did in the 1960s after President Kennedy's tax rate cuts. Robert Rubin and others reply that the economy boomed in the 1990s too, after Bill Clinton raised taxes. But supply-siders never argued that only tax cuts matter. Trade matters. Sound money matters. Regulations matter. In the 1990s, monetary, trade and spending policies were all leaning in a pro-growth direction, possibly offsetting the negative impact of the Clinton tax rate hikes.
What the critics have no plausible answer for is this: If the supply-side tax rate reduction model is truly so abhorrent, why are so many nations around the world latching on to it? What explains the Irish Miracle? Why are Germany, France and the U.K. slashing their corporate tax rates? Why are there 18 countries with flat taxes? Are their leaders deranged, or been bamboozled by crackpots? Perhaps a better explanation is that they know intuitively what a new National Bureau of Economic Research study has found: Nations with low tax rates on business have statistically significant higher rates of new business formation, investment and income.
History is clearly not on the side of the antisupply-side attack dogs, and they're losing the policy debate every day in political capitals around the world. Poland just announced it wants to implement a 15% flat tax by 2009. But the American left's obsession with the notion that tax rates don't matter tells us something important about the future. They are preparing the ground for massive tax increases if and when they capture control of the presidency.
I asked Rep. Paul Ryan of Wisconsin, a leading economic policy maker in the GOP, how many of the Democrats he works with buy into these screeds against supply-side economics. "Are you, kidding?" he replied. "Every one of the Democrats who sits in the front row of the Ways and Means Committee does. They've already got Charlie Rangel's tax increase baked into the cake."
Estonia, anyone?
[Mr. Moore is senior economics writer for the Wall Street Journal editorial board.]
Time to Talk Up the [US] Dollar
The more credible the currency regime, the greater the demand for the money issued.
By John Tamny
National Review Online
NOV 12, 2007
While stock markets continue to gyrate amidst domestic and world uncertainty, the dollar’s fall has become an even more pressing issue. Rate hikes initiated in 2004 didn’t arrest its downdraft, just as rate cuts of more recent vintage have occurred alongside further dollar weakness.
Much of the recent talk about the need to prop up the dollar has centered on the money supply and the Federal Reserve’s interest-rate lever. But very little has been said about the demand side of the money equation, whereby we get the principle: The more credible the currency regime, the greater the demand for the money issued.
The U.S. learned this lesson the hard way in the aftermath of President Nixon’s decision to close the gold window in August 1971. When currencies around the world fell in response to Nixon’s move, a system of fixed exchange rates was quickly put together. Unfortunately, the dollar’s new position wasn’t taken seriously by the markets, resulting in a substantial flight away from dollars and into the more credible currencies offered by Japan and Germany. The era of floating currencies had begun.
By 1975 floating currencies had created short-term trade advantages at the expense of long-term economic health for the devaluing countries, with the U.S. a frequent miscreant when it came to using devaluation as an export tool. When Carter Treasury secretary Michael Blumenthal communicated his desire for a weaker dollar against the yen in 1977 ”” despite a Fed that was raising its funds rate in large chunks ”” the markets eagerly complied.
At the time, worried investors sought to move into the most credible currencies available. And with the U.S. not offering up a reliable dollar, other countries would fill the void. For instance, Switzerland’s monetary base grew only 1 percent in 1977. In 1978, however, after making clear its desire to maintain a strong, stable franc, the Swiss money base grew 19.7 percent. The dollar’s base grew 8.2 percent over the same timeframe, yet the U.S. experienced a 13 percent price inflation between 1979 and 1980 compared with Switzerland’s 4.5 percent rate.
Another seeming paradox emerges when comparing the direction of the dollar in the 1970s and 1980s. It is often said that the Fed’s expansion of the monetary base gave us the inflationary 1970s. But measured in supply terms, the story is much more nuanced. The monetary base did grow 111 percent in the 1970s, but the Fed oversaw nearly identical money growth of 109 percent in the 1980s, the decade in which inflation was tamed. The difference in the latter decade was that a president offered tax cuts and deregulation as a tonic for the growth that was meant to restore the value of the dollar.
And now back to 2007. Portfolio manager Stephen Shipman noted recently that the amount of high-powered money being created by the Fed is actually lower today than it was in May, a situation one would think would equate with a strong greenback. Yet despite this fact, the dollar almost daily tests new all-time lows with no end in sight. What to do? Though Treasury secretary Henry Paulson is on record saying markets should set the dollar’s value, this form of “benign neglect” seems a bit wanting given the dollar’s direction.
Faced with a falling pound in the 1980s, Margaret Thatcher’s Chancellor of the Exchequer Nigel Lawson communicated to the markets his desire for an exchange rate of one pound to three deutschemarks. The markets matched his desires almost instantaneously. While it’s unrealistic to assume Paulson will seek a direct currency link with the euro, a strongly worded communiqué from the secretary that makes plain his unhappiness with the dollar’s fall will at least give traders a story to support resumed dollar buying. It also could present a way out of what could be a painful inflationary episode.
”” John Tamny is editor of RealClearMarkets and a senior economist with H. C. Wainwright Economics.
The more credible the currency regime, the greater the demand for the money issued.
By John Tamny
National Review Online
NOV 12, 2007
While stock markets continue to gyrate amidst domestic and world uncertainty, the dollar’s fall has become an even more pressing issue. Rate hikes initiated in 2004 didn’t arrest its downdraft, just as rate cuts of more recent vintage have occurred alongside further dollar weakness.
Much of the recent talk about the need to prop up the dollar has centered on the money supply and the Federal Reserve’s interest-rate lever. But very little has been said about the demand side of the money equation, whereby we get the principle: The more credible the currency regime, the greater the demand for the money issued.
The U.S. learned this lesson the hard way in the aftermath of President Nixon’s decision to close the gold window in August 1971. When currencies around the world fell in response to Nixon’s move, a system of fixed exchange rates was quickly put together. Unfortunately, the dollar’s new position wasn’t taken seriously by the markets, resulting in a substantial flight away from dollars and into the more credible currencies offered by Japan and Germany. The era of floating currencies had begun.
By 1975 floating currencies had created short-term trade advantages at the expense of long-term economic health for the devaluing countries, with the U.S. a frequent miscreant when it came to using devaluation as an export tool. When Carter Treasury secretary Michael Blumenthal communicated his desire for a weaker dollar against the yen in 1977 ”” despite a Fed that was raising its funds rate in large chunks ”” the markets eagerly complied.
At the time, worried investors sought to move into the most credible currencies available. And with the U.S. not offering up a reliable dollar, other countries would fill the void. For instance, Switzerland’s monetary base grew only 1 percent in 1977. In 1978, however, after making clear its desire to maintain a strong, stable franc, the Swiss money base grew 19.7 percent. The dollar’s base grew 8.2 percent over the same timeframe, yet the U.S. experienced a 13 percent price inflation between 1979 and 1980 compared with Switzerland’s 4.5 percent rate.
Another seeming paradox emerges when comparing the direction of the dollar in the 1970s and 1980s. It is often said that the Fed’s expansion of the monetary base gave us the inflationary 1970s. But measured in supply terms, the story is much more nuanced. The monetary base did grow 111 percent in the 1970s, but the Fed oversaw nearly identical money growth of 109 percent in the 1980s, the decade in which inflation was tamed. The difference in the latter decade was that a president offered tax cuts and deregulation as a tonic for the growth that was meant to restore the value of the dollar.
And now back to 2007. Portfolio manager Stephen Shipman noted recently that the amount of high-powered money being created by the Fed is actually lower today than it was in May, a situation one would think would equate with a strong greenback. Yet despite this fact, the dollar almost daily tests new all-time lows with no end in sight. What to do? Though Treasury secretary Henry Paulson is on record saying markets should set the dollar’s value, this form of “benign neglect” seems a bit wanting given the dollar’s direction.
Faced with a falling pound in the 1980s, Margaret Thatcher’s Chancellor of the Exchequer Nigel Lawson communicated to the markets his desire for an exchange rate of one pound to three deutschemarks. The markets matched his desires almost instantaneously. While it’s unrealistic to assume Paulson will seek a direct currency link with the euro, a strongly worded communiqué from the secretary that makes plain his unhappiness with the dollar’s fall will at least give traders a story to support resumed dollar buying. It also could present a way out of what could be a painful inflationary episode.
”” John Tamny is editor of RealClearMarkets and a senior economist with H. C. Wainwright Economics.
From The Times, London, UK
January 14, 2008
Goodbye to all that: the worst is over for the global credit crunch
Anatole Kaletsky: Economic view
Global stock markets have suffered their worst early-January trading since records began in the 1920s. Conventional wisdom is again overwhelmingly gloomy - about the global economy, the asset markets and even the sustainability of the global financial and trading systems. However, conditions are not nearly as bad as the headlines and market pundits suggest. In Britain, there seems to be almost no chance of economic and financial disasters comparable to those suffered from 1990 to 1992.
In the 17 years that I have been writing these Economic Views, I have devoted my first article in January to challenging, where appropriate, the conventional wisdom about the world economy in the year ahead. Here, then, are five ways in which I think conventional wisdom seems worth challenging in 2008:
1. I believe that the global credit crisis, far from taking a turn for the worse, is now almost over. Since the beginning of this year, credit spreads in the inter-bank market have returned to normal. This is the first sign of the financial system beginning to heal. In the next six weeks all the leading banks will report their year-end results and will announce further big write-offs to cope with the sub-prime crisis. There is a decent chance that investors will recognise these as the final big write-offs. The banks will then recapitalise and return to more or less normal operations.
If, however, this market-based resolution of the credit crisis does not occur and investors continue to question the integrity of bank balance sheets, the world’s monetary authorities will, I suspect, come out with a Plan B. At a minimum, there could be some new international agreement on new models for valuing illiquid assets such as the mortgage-backed securities now paralysing the banks.
At the maximum, the US and European governments will announce public backing for their national mortgage and banking systems – similar to the action already taken by Gordon Brown to guarantee the deposits in the entire British banking system. The credit crisis will have to be resolved by the end of February, if not by the markets, then by governments and central banks. The world economy simply cannot afford to wait much longer for normal service by the banking system to be resumed.
2. There will be no US recession. Until a few days ago, this would not have qualified as an unconventional prediction, since almost no serious economic forecasters anywhere in the world were predicting a recession. In the past week, however, Merrill Lynch, Goldman Sachs and Morgan Stanley have all publicly said that a US recession this year was very probable and may well have started already. I still believe it will be avoided because US interest rates are so low that businesses and consumers will go on spending – and, even more importantly, the Federal Reserve Board has now indicated a willingness to cut interest rates aggressively and keep cutting until the economy revives. Having said this, I must admit that a recession now looks much more likely than it did even a month ago. Whether a recession occurs or is narrowly avoided makes a big difference, because any market economy is similar to an aircraft that has to fly at a minimum speed to avoid crashing. History shows that the US economy’s “stall speed” is around 1.5 per cent in terms of GDP growth. If it slows any further, it is liable to crash and suffer a period of significantly negative growth. In the remaining predictions, therefore, I will give two variants, depending on whether the US crashes into recession or manages to stay aloft.
3. Stock markets around the world will rise in 2008. Valuations of many companies are now very attractive, even on the assumption of a severe slowdown in global growth and a year of falling profits. Moreover, investor sentiment is more bearish than at any time since 1990 – suggesting that a lot of very bad news has already been discounted in market prices. This means that if there is no recession, shares probably should stabilise at around present levels, but may not make much progress until the second half of the year. If, on the other hand, the United States does sink into recession, Wall Street will suffer a more severe bear market in the next few months, but prices will start to rebound sharply well before the recession ends. This recession rebound should start once US short-term interest rates fall well below long-term bond yields. This should happen by March, assuming that the Fed cuts interest rates from the present 4.5 per cent to around 3.5 per cent.
Either way, equity prices are likely to end 2008 at higher levels than they began. In Britain and Europe, interest rates are also likely to be reduced by at least 1.5 percentage points in the 12 months ahead.
But the rate cuts will happen later and more slowly. This is one reason why the outlook for the US economy and stock market is a lot better than it is for Britain and Europe.
4. The much-discussed “decoupling” between America and the rest of the world economy will happen in the case of Asia, but not Europe. Asia will continue to grow rapidly this year. However, Asian stock markets will not decouple if the US sinks into recession and Wall Street therefore suffers a full-blown bear market. In that case, Asian equities will suffer even bigger falls than US shares.
Europe and Britain, by contrast, will certainly be dragged down if the US sinks into recession and will do relatively poorly even if (as I expect) the US slowdown turns out to be less severe.
The main European economies, apart from Germany, have been powered by exactly the same combination of rising house prices and easy credit as the US economy. They are simply 12 to 18 months behind the US in the same credit cycle. Germany, meanwhile, is very dependent on the strength of consumer demand in the rest of Europe. The best that Europe and Britain can expect, therefore, is a performance in the economy and housing markets similar to America’s in 2007. If the US suffers a recession, the housing and consumer slumps in Europe and Britain will be that much more severe.
5. In the currency markets, sterling will continue to fall against every other leading currency, partly because Britain is so vulnerable to a serious setback in housing. By the second half of 2008, however, the euro will take over from the pound as the pariah of the global currency markets, since the eurozone will ultimately suffer more than Britain from the slowdown in the global economy because the European Central Bank will resist making the inevitable interest-rate cuts.
This intransigence by the ECB will cause serious economic and political disruptions in Europe – and could even raise questions about the euro’s survival as a reserve currency in the long term.
January 14, 2008
Goodbye to all that: the worst is over for the global credit crunch
Anatole Kaletsky: Economic view
Global stock markets have suffered their worst early-January trading since records began in the 1920s. Conventional wisdom is again overwhelmingly gloomy - about the global economy, the asset markets and even the sustainability of the global financial and trading systems. However, conditions are not nearly as bad as the headlines and market pundits suggest. In Britain, there seems to be almost no chance of economic and financial disasters comparable to those suffered from 1990 to 1992.
In the 17 years that I have been writing these Economic Views, I have devoted my first article in January to challenging, where appropriate, the conventional wisdom about the world economy in the year ahead. Here, then, are five ways in which I think conventional wisdom seems worth challenging in 2008:
1. I believe that the global credit crisis, far from taking a turn for the worse, is now almost over. Since the beginning of this year, credit spreads in the inter-bank market have returned to normal. This is the first sign of the financial system beginning to heal. In the next six weeks all the leading banks will report their year-end results and will announce further big write-offs to cope with the sub-prime crisis. There is a decent chance that investors will recognise these as the final big write-offs. The banks will then recapitalise and return to more or less normal operations.
If, however, this market-based resolution of the credit crisis does not occur and investors continue to question the integrity of bank balance sheets, the world’s monetary authorities will, I suspect, come out with a Plan B. At a minimum, there could be some new international agreement on new models for valuing illiquid assets such as the mortgage-backed securities now paralysing the banks.
At the maximum, the US and European governments will announce public backing for their national mortgage and banking systems – similar to the action already taken by Gordon Brown to guarantee the deposits in the entire British banking system. The credit crisis will have to be resolved by the end of February, if not by the markets, then by governments and central banks. The world economy simply cannot afford to wait much longer for normal service by the banking system to be resumed.
2. There will be no US recession. Until a few days ago, this would not have qualified as an unconventional prediction, since almost no serious economic forecasters anywhere in the world were predicting a recession. In the past week, however, Merrill Lynch, Goldman Sachs and Morgan Stanley have all publicly said that a US recession this year was very probable and may well have started already. I still believe it will be avoided because US interest rates are so low that businesses and consumers will go on spending – and, even more importantly, the Federal Reserve Board has now indicated a willingness to cut interest rates aggressively and keep cutting until the economy revives. Having said this, I must admit that a recession now looks much more likely than it did even a month ago. Whether a recession occurs or is narrowly avoided makes a big difference, because any market economy is similar to an aircraft that has to fly at a minimum speed to avoid crashing. History shows that the US economy’s “stall speed” is around 1.5 per cent in terms of GDP growth. If it slows any further, it is liable to crash and suffer a period of significantly negative growth. In the remaining predictions, therefore, I will give two variants, depending on whether the US crashes into recession or manages to stay aloft.
3. Stock markets around the world will rise in 2008. Valuations of many companies are now very attractive, even on the assumption of a severe slowdown in global growth and a year of falling profits. Moreover, investor sentiment is more bearish than at any time since 1990 – suggesting that a lot of very bad news has already been discounted in market prices. This means that if there is no recession, shares probably should stabilise at around present levels, but may not make much progress until the second half of the year. If, on the other hand, the United States does sink into recession, Wall Street will suffer a more severe bear market in the next few months, but prices will start to rebound sharply well before the recession ends. This recession rebound should start once US short-term interest rates fall well below long-term bond yields. This should happen by March, assuming that the Fed cuts interest rates from the present 4.5 per cent to around 3.5 per cent.
Either way, equity prices are likely to end 2008 at higher levels than they began. In Britain and Europe, interest rates are also likely to be reduced by at least 1.5 percentage points in the 12 months ahead.
But the rate cuts will happen later and more slowly. This is one reason why the outlook for the US economy and stock market is a lot better than it is for Britain and Europe.
4. The much-discussed “decoupling” between America and the rest of the world economy will happen in the case of Asia, but not Europe. Asia will continue to grow rapidly this year. However, Asian stock markets will not decouple if the US sinks into recession and Wall Street therefore suffers a full-blown bear market. In that case, Asian equities will suffer even bigger falls than US shares.
Europe and Britain, by contrast, will certainly be dragged down if the US sinks into recession and will do relatively poorly even if (as I expect) the US slowdown turns out to be less severe.
The main European economies, apart from Germany, have been powered by exactly the same combination of rising house prices and easy credit as the US economy. They are simply 12 to 18 months behind the US in the same credit cycle. Germany, meanwhile, is very dependent on the strength of consumer demand in the rest of Europe. The best that Europe and Britain can expect, therefore, is a performance in the economy and housing markets similar to America’s in 2007. If the US suffers a recession, the housing and consumer slumps in Europe and Britain will be that much more severe.
5. In the currency markets, sterling will continue to fall against every other leading currency, partly because Britain is so vulnerable to a serious setback in housing. By the second half of 2008, however, the euro will take over from the pound as the pariah of the global currency markets, since the eurozone will ultimately suffer more than Britain from the slowdown in the global economy because the European Central Bank will resist making the inevitable interest-rate cuts.
This intransigence by the ECB will cause serious economic and political disruptions in Europe – and could even raise questions about the euro’s survival as a reserve currency in the long term.
Re: Best Financial Quotes of 2008
Reuters reports on some interesting comments from Warren Buffett, the legendary value investor, about the troubles facing many of the biggest financial firms:
The woes in the United States financial sector are “poetic justice” for bankers who designed and sold complex investments that have since gone sour, Mr. Buffett said on Wednesday.
Mr. Buffett, the head of Berkshire Hathaway and one of the world’s wealthiest people, appeared to see irony in the fallout hitting many of the banks who marketed complex investments that have now crashed.
“It’s sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end,” Mr. Buffett said during a question and answer session at a business event in Toronto.
Mr. Buffett also played down worries about a credit crunch by saying that recent interest rate cuts mean low-cost funds are readily available.
Instead, he said, the turmoil that has rocked the nation’s economy in recent months has imbued the markets with a healthy degree of caution, while the rate-cutting response from central bankers has ensured that cheap money remains available for borrowing.
“I wouldn’t quite call it a credit crunch. Funds are available,” Mr. Buffett said. “Money is available, and it’s really quite cheap because of the lowering of rates that has taken place.”
He added: “What has happened is a repricing of risk and an unavailability of what I might call ‘dumb money,’ of which there was plenty around a year ago.”
Source: NY Times, 7 FEB 2008
Reuters reports on some interesting comments from Warren Buffett, the legendary value investor, about the troubles facing many of the biggest financial firms:
The woes in the United States financial sector are “poetic justice” for bankers who designed and sold complex investments that have since gone sour, Mr. Buffett said on Wednesday.
Mr. Buffett, the head of Berkshire Hathaway and one of the world’s wealthiest people, appeared to see irony in the fallout hitting many of the banks who marketed complex investments that have now crashed.
“It’s sort of a little poetic justice, in that the people that brewed this toxic Kool-Aid found themselves drinking a lot of it in the end,” Mr. Buffett said during a question and answer session at a business event in Toronto.
Mr. Buffett also played down worries about a credit crunch by saying that recent interest rate cuts mean low-cost funds are readily available.
Instead, he said, the turmoil that has rocked the nation’s economy in recent months has imbued the markets with a healthy degree of caution, while the rate-cutting response from central bankers has ensured that cheap money remains available for borrowing.
“I wouldn’t quite call it a credit crunch. Funds are available,” Mr. Buffett said. “Money is available, and it’s really quite cheap because of the lowering of rates that has taken place.”
He added: “What has happened is a repricing of risk and an unavailability of what I might call ‘dumb money,’ of which there was plenty around a year ago.”
Source: NY Times, 7 FEB 2008
Re: Best Financial Quotes of 2008
Warning signs of a modern depression
http://seekingalpha.com/article/687...on-see-1990-japan?source=d_email#comment_form
Warning signs of a modern depression
http://seekingalpha.com/article/687...on-see-1990-japan?source=d_email#comment_form
Re: Best Financial Quotes of 2008
Economic Scene
Can’t Grasp Credit Crisis? Join the Club
By DAVID LEONHARDT | The New York Times | March 19, 2008
Raise your hand if you don’t quite understand this whole financial crisis.
It has been going on for seven months now, and many people probably feel as if they should understand it. But they don’t, not really. The part about the housing crash seems simple enough. With banks whispering sweet encouragement, people bought homes they couldn’t afford, and now they are falling behind on their mortgages.
But the overwhelming majority of homeowners are doing just fine. So how is it that a mess concentrated in one part of the mortgage business ”” subprime loans ”” has frozen the credit markets, sent stock markets gyrating, caused the collapse of Bear Stearns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?
I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.
“We’re exposing parts of the capital markets that most of us had never heard of,” Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former Treasury secretary and current Citigroup executive, has said that he hadn’t heard of “liquidity puts,” an obscure kind of financial contract, until they started causing big problems for Citigroup.
I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, “Can you try to explain this to me?” When they finished, I often had a highly sophisticated follow-up question: “Can you try again?”
I emerged thinking that all the uncertainty has created a panic that is partly unfounded. That said, the crisis isn’t close to ending, either. Ben Bernanke, the Federal Reserve chairman, won’t be able to wave a magic wand and make everything better, no matter how many more times he cuts rates. As Mr. Bernanke himself has suggested, the only thing that will end the crisis is the end of the housing bust.
So let’s go back to the beginning of the boom.
It really started in 1998, when large numbers of people decided that real estate, which still hadn’t recovered from the early 1990s slump, had become a bargain. At the same time, Wall Street was making it easier for buyers to get loans. It was transforming the mortgage business from a local one, centered around banks, to a global one, in which investors from almost anywhere could pool money to lend.
The new competition brought down mortgage fees and spurred some useful innovation. Why, after all, should someone who knows that she’s going to move after just a few years have no choice but to take out a 30-year fixed-rate mortgage?
As is often the case with innovations, though, there was soon too much of a good thing. Those same global investors, flush with cash from Asia’s boom or rising oil prices, demanded good returns. Wall Street had an answer: subprime mortgages.
Because these loans go to people stretching to afford a house, they come with higher interest rates ”” even if they’re disguised by low initial rates ”” and thus higher returns. The mortgages were then sliced into pieces and bundled into investments, often known as collateralized debt obligations, or C.D.O.’s (a term that appeared in this newspaper only three times before 2005, but almost every week since last summer). Once bundled, different types of mortgages could be sold to different groups of investors.
Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money. Home buyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody’s Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years.
All these investments, of course, were highly risky. Higher returns almost always come with greater risk. But people ”” by “people,” I’m referring here to Mr. Greenspan, Mr. Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners ”” decided that the usual rules didn’t apply because home prices nationwide had never fallen before. Based on that idea, prices rose ever higher ”” so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy.
And it largely explains why the mortgage mess has had such ripple effects. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it. Last summer, many policy makers were hoping that the crisis wouldn’t spread to traditional banks, like Citibank, because they had sold off the underlying mortgages to investors. But it turned out that many banks had also sold complex insurance policies on the mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by flipping their house for a profit.
Many of these bets were not huge, but were so highly leveraged that any losses became magnified. If that $100 million investment I described above were to lose just $1 million of its value, the investor who put up only $1 million would lose everything. That’s why a hedge fund associated with the prestigious Carlyle Group collapsed last week.
“If anything goes awry, these dominos fall very fast,” said Charles R. Morris, a former banker who tells the story of the crisis in a new book, “The Trillion Dollar Meltdown.”
This toxic combination ”” the ubiquity of bad investments and their potential to mushroom ”” has shocked Wall Street into a state of deep conservatism. The soundness of any investment firm depends largely on other firms having confidence that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are. Any institution that seems to have a high-risk portfolio, regardless of whether it has enough assets to support the portfolio, faces the double whammy of investors demanding their money back and lenders shutting the door in their face. Goodbye, Bear Stearns.
The conservatism has gone so far that it’s affecting many solid would-be borrowers, which, in turn, is hurting the broader economy and aggravating Wall Streets fears. A recession could cause credit card loans and other forms of debt, some of which were also based on overexuberance, to start going bad as well.
Many economists, on the right and the left, now argue that the only solution is for the federal government to step in and buy some of the unwanted debt, as the Fed began doing last weekend. This is called a bailout, and there is no doubt that giving a handout to Wall Street lenders or foolish home buyers ”” as opposed to, say, laid-off factory workers ”” is deeply distasteful. At this point, though, the alternative may be worse.
Bubbles lead to busts. Busts lead to panics. And panics can lead to long, deep economic downturns, which is why the Fed has been taking unprecedented actionto restore confidence.
“You say, my goodness, how could subprime mortgage loans take out the whole global financial system?” Mr. Zandi said. “That’s how.”
Economic Scene
Can’t Grasp Credit Crisis? Join the Club
By DAVID LEONHARDT | The New York Times | March 19, 2008
Raise your hand if you don’t quite understand this whole financial crisis.
It has been going on for seven months now, and many people probably feel as if they should understand it. But they don’t, not really. The part about the housing crash seems simple enough. With banks whispering sweet encouragement, people bought homes they couldn’t afford, and now they are falling behind on their mortgages.
But the overwhelming majority of homeowners are doing just fine. So how is it that a mess concentrated in one part of the mortgage business ”” subprime loans ”” has frozen the credit markets, sent stock markets gyrating, caused the collapse of Bear Stearns, left the economy on the brink of the worst recession in a generation and forced the Federal Reserve to take its boldest action since the Depression?
I’m here to urge you not to feel sheepish. This may not be entirely comforting, but your confusion is shared by many people who are in the middle of the crisis.
“We’re exposing parts of the capital markets that most of us had never heard of,” Ethan Harris, a top Lehman Brothers economist, said last week. Robert Rubin, the former Treasury secretary and current Citigroup executive, has said that he hadn’t heard of “liquidity puts,” an obscure kind of financial contract, until they started causing big problems for Citigroup.
I spent a good part of the last few days calling people on Wall Street and in the government to ask one question, “Can you try to explain this to me?” When they finished, I often had a highly sophisticated follow-up question: “Can you try again?”
I emerged thinking that all the uncertainty has created a panic that is partly unfounded. That said, the crisis isn’t close to ending, either. Ben Bernanke, the Federal Reserve chairman, won’t be able to wave a magic wand and make everything better, no matter how many more times he cuts rates. As Mr. Bernanke himself has suggested, the only thing that will end the crisis is the end of the housing bust.
So let’s go back to the beginning of the boom.
It really started in 1998, when large numbers of people decided that real estate, which still hadn’t recovered from the early 1990s slump, had become a bargain. At the same time, Wall Street was making it easier for buyers to get loans. It was transforming the mortgage business from a local one, centered around banks, to a global one, in which investors from almost anywhere could pool money to lend.
The new competition brought down mortgage fees and spurred some useful innovation. Why, after all, should someone who knows that she’s going to move after just a few years have no choice but to take out a 30-year fixed-rate mortgage?
As is often the case with innovations, though, there was soon too much of a good thing. Those same global investors, flush with cash from Asia’s boom or rising oil prices, demanded good returns. Wall Street had an answer: subprime mortgages.
Because these loans go to people stretching to afford a house, they come with higher interest rates ”” even if they’re disguised by low initial rates ”” and thus higher returns. The mortgages were then sliced into pieces and bundled into investments, often known as collateralized debt obligations, or C.D.O.’s (a term that appeared in this newspaper only three times before 2005, but almost every week since last summer). Once bundled, different types of mortgages could be sold to different groups of investors.
Investors then goosed their returns through leverage, the oldest strategy around. They made $100 million bets with only $1 million of their own money and $99 million in debt. If the value of the investment rose to just $101 million, the investors would double their money. Home buyers did the same thing, by putting little money down on new houses, notes Mark Zandi of Moody’s Economy.com. The Fed under Alan Greenspan helped make it all possible, sharply reducing interest rates, to prevent a double-dip recession after the technology bust of 2000, and then keeping them low for several years.
All these investments, of course, were highly risky. Higher returns almost always come with greater risk. But people ”” by “people,” I’m referring here to Mr. Greenspan, Mr. Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners ”” decided that the usual rules didn’t apply because home prices nationwide had never fallen before. Based on that idea, prices rose ever higher ”” so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy.
And it largely explains why the mortgage mess has had such ripple effects. The American home seemed like such a sure bet that a huge portion of the global financial system ended up owning a piece of it. Last summer, many policy makers were hoping that the crisis wouldn’t spread to traditional banks, like Citibank, because they had sold off the underlying mortgages to investors. But it turned out that many banks had also sold complex insurance policies on the mortgage debt. That left them on the hook when homeowners who had taken out a wishful-thinking mortgage could no longer get out of it by flipping their house for a profit.
Many of these bets were not huge, but were so highly leveraged that any losses became magnified. If that $100 million investment I described above were to lose just $1 million of its value, the investor who put up only $1 million would lose everything. That’s why a hedge fund associated with the prestigious Carlyle Group collapsed last week.
“If anything goes awry, these dominos fall very fast,” said Charles R. Morris, a former banker who tells the story of the crisis in a new book, “The Trillion Dollar Meltdown.”
This toxic combination ”” the ubiquity of bad investments and their potential to mushroom ”” has shocked Wall Street into a state of deep conservatism. The soundness of any investment firm depends largely on other firms having confidence that it has real assets standing behind its bets. So firms are now hoarding cash instead of lending it, until they understand how bad the housing crash will become and how exposed to it they are. Any institution that seems to have a high-risk portfolio, regardless of whether it has enough assets to support the portfolio, faces the double whammy of investors demanding their money back and lenders shutting the door in their face. Goodbye, Bear Stearns.
The conservatism has gone so far that it’s affecting many solid would-be borrowers, which, in turn, is hurting the broader economy and aggravating Wall Streets fears. A recession could cause credit card loans and other forms of debt, some of which were also based on overexuberance, to start going bad as well.
Many economists, on the right and the left, now argue that the only solution is for the federal government to step in and buy some of the unwanted debt, as the Fed began doing last weekend. This is called a bailout, and there is no doubt that giving a handout to Wall Street lenders or foolish home buyers ”” as opposed to, say, laid-off factory workers ”” is deeply distasteful. At this point, though, the alternative may be worse.
Bubbles lead to busts. Busts lead to panics. And panics can lead to long, deep economic downturns, which is why the Fed has been taking unprecedented actionto restore confidence.
“You say, my goodness, how could subprime mortgage loans take out the whole global financial system?” Mr. Zandi said. “That’s how.”
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