Category Archives: Financial Crisis

New banks, not government banks

Niall Ferguson’s latest:

The critical point is to avoid the nightmare of a state-dominated financial sector. The last thing America needs is to have all its banks run like the rail company Amtrak or, worse, the Internal Revenue Service. State life-support for moribund dinosaur banks is an expedient designed to avert the disaster of a generalised banking extinction not a belated victory for socialism. It should not and must not impede the formation of new banks by the private sector. So recapitalisation must be a once-only event, with no enduring government guarantees or subsidies.

What’s lost vs. what might be gained

David Malpass with a typically cogent column on the crisis of lost capital and plunging consumption, but also the more important factors that drive the future.

Losses in U.S. wealth and self-confidence have been massive, with job conditions still worsening. But a long downtrend into 2010 isn’t inevitable, even assuming a systematic lurch to bigger government. A starting point for optimism is to realize that the creation of new capital is more important than the loss of old capital. This is hard to absorb emotionally during a crisis. The world’s past wealth creation is outstripped every generation by innovation, human progress and the rapid growth of the above-subsistence population.

Consumption may also prove less important to the recovery than asserted in the warnings of another Great Depression. Consumption crashed after theLehman Brothers bankruptcy. With consumption equaling 70% of GDP, a downsizing there would decimate GDP if the economy were static. Yet GDP itself means production, not consumption. A lot of U.S. consumption has been idle or is sourced abroad and won’t be missed. The GDP issue is whether the Crash of ’08 will cause people to work fewer years, less hard or less productively. That’s unlikely.

Even for those deeply worried about old capital and weak consumption there are grounds for optimism. So far most of the banking sector losses have been accounting writedowns, not cash losses. Layoffs would slow and consumption resume if the Fed sped its asset purchases and Washington stopped imposing arbitrarily low prices on equity holders and regulatory capital in the blind assumption that crisis markets are accurately priced.

The Real China Story

The New York Times, in its series on the origins of the financial crisis it calls “The Reckoning,” pins our housing and credit bubbles on Chinese savings and the U.S.-China trade gap. This is basically the view of Alan Greenspan and Ben Bernanke. We were helpless. Monetary policy had become ineffective. The New York Times also says the U.S. failed to react to the China-U.S. “imbalances” soon enough, that we took a “passive” approach. 

In fact, most of this is backward. We did not under-react to China. We overreacted. The U.S. weak-dollar policy — a combination of historically low Fed interest rates and a Treasury calling for a cheaper currency — was a direct and violent reaction to the trade gap. A series of Treasury secretaries and top U.S. economists, from John Snow and Hank Paulson to John Taylor and Martin Feldstein, explicitly backed this policy as a way to “correct” these “imbalances.” This weak-dollar policy was designed to reduce the trade gap but in fact boosted it by pushing oil and other commodity prices through the roof. It also created and pushed excess dollars into other hard assets like real estate, resulting in the housing boom and then bust.

America’s overreaction to China’s rise in particular and our misunderstanding of global trade and finance in general was thus, I believe, the chief source of our current predicament. The Fed and Treasury failed to grasp the truly global nature of the economy and the centrality of the dollar around the world. I tell the story of Chinese-U.S. interaction in this long paper, “Entrepreneurship and Innovation in China: 1978-2008.”

The Madoff Maneuver?

Andy Kessler wonders:

If you’re going to go down, you might as well go big and get something named after you. Why should Ponzi keep hogging the limelight?

What not to do

The Wall Street Journal documents Japan’s endless series of profligate pump-priming “stimuli” in the 1990s.

The experiment, predictably, failed.

Here’s Dan Mitchell with a critique that goes beyond Japan:

Technology: 2008 vs. 1992

See my comparison of the state of technology in 2008 versus 1992, when the last Democratic presidential transition took place. 

Today, an average consumer can buy a terabyte hard drive (1 million megabytes), on which she might store her family photos, videos and other digital documents for as little as $109.99. In 1992, a terabyte drive, if such a thing had existed, would have cost $5 million.

Go to for the full article: “How Techno-creativity Will Save Us.”

Money Map

See Slate’s interactive guide to the bailout(s) (plural) (ad infinitum). Total committed so far: $5.596 trillion.

“Not just worse…a lot worse”

That, it seems, is the economic prognosis of the Obama financial team, looking ahead at a total global “demand collapse” and the total failure of fragile states like Pakistan.

the sense I get from them is that they are very worried that the economy will get a lot worse before it gets better. Not just worse… a lot worse. As in — double digit unemployment without the wiggle factors. Huge declines in aggregate demand. Significant, persistent deficits. That’s one reason why the Obama administration seems to be open to listening to every economist with an idea and is stocking the staff with the leading lights of the field. . . .

Where the discussion isn’t going, at least in public,  (or the PR level), is the possibility that the first foreign policy crisis the administration will face will be the complete economic collapse of a large, unstable nation. To be sure, Pakistan is nearly broke, and U.S. policy makers seem to be aware of that; but a worldwide demand crisis could lead to social unrest in countries like Indonesia and Malaysia, Singapore, the Ukraine, Japan, Turkey or Egypt (which is facing an internal political crisis of epic proportions already). The U.S. won’t have the resources to, say, engineer the rescue of the peso again, or intervene in Asia as in 1997. 

Team Obama may believe this. And they may be right. But it probably doesn’t hurt their cause to make people think they believe this. If things do get much worse, they can say they anticipated it. If things improve, they can take credit for a heroic and historic rescue. (See, “Committee to Save the World.” ca. 1999.)

To a number of smart people, all this seems like too much “depression lust.”


My old college roommate Jared Polis, soon to be a Democratic Congressman from Colorado, pens a terrific op-ed in today’s Wall Street Journal offering a unique non-bail-out solution to the automobile meltdown.

By waiving the future capital-gains tax on all investments in the automobile industry, we enhance the projected return models and therefore the likely occurrence of a privately funded “bailout.” There are turnaround firms and funds, and they are experts at what needs to be done. Tax exemption for gains would certainly get their attention. It also wouldn’t cost taxpayers anything because it only forgoes future government revenues that wouldn’t exist absent this incentive.

Danger Zone

We are in a new, if entirely predictable, danger zone. The State of Illinois and City of Chicago are now ceasing business with Bank of America because BofA declined to extend credit to Republic Windows and Doors, a plant where workers are now engaged in a sit-in. 

The take-over of much of the U.S. financial industry — with health care and maybe energy next — could lead to endless mischief of this sort and much worse.

A friend writes to say: “fascism has come to America.” Alarmist, or prophetic?

Mark to Mayhem

Brian Wesbury expands on a chief cause of the vortex that took down the U.S. financial sector.

Suspending mark-to-market accounting will not keep institutions that took excessive risk from failing. Bad loans are still bad loans and there is no way to avoid the pain that they cause. It will, however, end the negative feedback loop, which drags everyone down. It allows time to see if the wind shifts and keeps the flames from spreading.

In the 1980s, loan problems took down thousands of banks, but because we did not force fair value accounting, the economy and stock market actually thrived. Every money center bank would have been insolvent in the early 1980s if they were forced to write down Latin American debt to 10 cents on the dollar. Add in bad oil loans which took down Pen Sqaure and Continental and bad S&L loans, and it is easy to see that the bank problems in the early 1980s were much more severe than those of the 2000s. But the rules were not as inflexible as their are today. Problems did not spread, many banks eventually recovered their principle on Latin American debt and the economy grew.

In contrast, today’s problems are expanding, and have now caused the government to put almost $4 trillion of taxpayer funds at risk to support the financial system. This is an amazing sum of money, equaling 28% of GDP, or 42% of total US stock market capitalization, or more than a quarter of all household debt outstanding, or nearly 40% of all private household mortgage debt, or three times the amount of subprime loans outstanding at their peak.

The government has tried multiple strategies. The only thing they have in common is that they are designed to offset or stop the damage caused by mark-to-market accounting.

“Where Was Geithner?”

Andrew Ross Sorkin asks a good question, and some Wall Streeters answered.

“We have only two things to say about Tim Geithner, who we do not know: A.I.G. and Lehman Brothers,” said Christopher Whalen of Institutional Risk Analytics. “Throw in the Bear Stearns/Maiden Lane fiasco for good measure,” he said.

“All of these ‘rescues’ are a disaster for the taxpayer, for the financial markets and also for the Federal Reserve System as an organization. Geithner, in our view, deserves retirement, not promotion.”

And perhaps the biggest bungle of them all:

It was Mr. Geithner, not Mr. Paulson, for example, who put together the original rescue plan for the American International Group.

AIG could probably have been saved with a bridge loan. But the government took 80% of the company. AIG set the precedent for wiping out equity shareholders and put other financial firms on the precipice and put a target on their back for short-seller snipers. In combination with a series of other errors — clearly not all Geithner’s fault or doing — this move helped undo Wall Street and continues to wreak havoc among insurance companies. 

It does appear that we are finally getting some much needed action on mortgage rates. Instead of focusing on “foreclosures,” the Treasury should have told Fannie and Freddie to lower their commitment rate, which would have automatically brought down mortgage rates, which have not followed the 10-year Treasury down. Lower mortgage rates could help restart turnover in the housing market and thus relieve much of the worst-case uncertainty in the MBS and larger credit markets. With the 10-year close to 3%, we could get 30-year mortgage rates into the mid-4s. Let’s hope, after lots of bumbling and fumbling, they’re finally moving in this direction.

The Panic of ’08: Or, How a Jamaican Nanny Ended Up With Five Homes

Whether the topic is football or finance, Michael Lewis is maybe the best non-fiction story teller of our times. Now this author of Liar’s Poker, the smart-ass inside tale of Eighties Wall Street excess, finds the man who helped expose today’s housing charade and learns about real excess — the ’80s, how quaint — as he chronicles the 2008 crash.

More generally, the subprime market tapped a tranche of the American public that did not typically have anything to do with Wall Street. Lenders were making loans to people who, based on their credit ratings, were less creditworthy than 71 percent of the population. Eisman knew some of these people. One day, his housekeeper, a South American woman, told him that she was planning to buy a townhouse in Queens. “The price was absurd, and they were giving her a low-down-payment option-ARM,” says Eisman, who talked her into taking out a conventional fixed-rate mortgage. Next, the baby nurse he’d hired back in 1997 to take care of his newborn twin daughters phoned him. “She was this lovely woman from Jamaica,” he says. “One day she calls me and says she and her sister own five townhouses in Queens. I said, ‘How did that happen?’ ” It happened because after they bought the first one and its value rose, the lenders came and suggested they refinance and take out $250,000, which they used to buy another one. Then the price of that one rose too, and they repeated the experiment. “By the time they were done,” Eisman says, “they owned five of them, the market was falling, and they couldn’t make any of the payments.”

But the sub-prime detective Eisman still had not fully grasped the enormity and breadth of the problem.

That’s when Eisman finally got it. Here he’d been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren’t enough Americans with shitty credit taking out loans to satisfy investors’ appetite for the end product. The firms used Eisman’s bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn’t create a second Peyton Manning to inflate the league’s stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. 

Finally, Lewis lunches with his long-ago boss John Gutfreund, the Salomon Brothers CEO who he skewered almost 30 years ago.

[Gutfreund] thought the cause of the financial crisis was “simple. Greed on both sides—greed of investors and the greed of the bankers.” I thought it was more complicated. Greed on Wall Street was a given—almost an obligation. The problem was the system of incentives that channeled the greed. 

Indeed, greed is ever-present. And not just on Wall Street. It is the incentives and discipline — the structure — of the market that keeps greed from pushing us over the cliff. It is this discipline of the market that makes service to others, in the words of George Gilder, more valuable than self-centered avarice. Had he taken it one step further, Lewis might have said that the ultimate disciplinarian — the taskmaster that demands real value instead of greed, froth, and fraud — is a rock-solid dollar.


The prolific Niall Ferguson with a long narrative of the financial crash in Vanity Fair:

The key point is that without easy credit creation a true bubble cannot occur. That is why so many bubbles have their origins in the sins of omission and commission of central banks. 

« Previous Page