Saturday, September 27, 2008

The Republican Legacy: The Worst Economic Crisis in Three Generations

Heckuva job Bush and his Republican friends have given us the credit crisis, the housing bust, the energy crisis, two budget-busting wars with the threat of a third and record oil company profits. Time and time again, the Republicans, including John McCain who doesn't know how many houses he has and who loves to buy stacks of $100 chips for gambling, have also offered giveaways to the rich who are already rich and don't need giveaways. Did I mention that we're in an economic crisis?

Did I also mention that every sane person in Congress is holding their nose because they are probably going to have to vote yes on a bailout plan that is certainly better than Bush's plan but far from ideal because Bush and Republicans refused to deal with the problem when it would have been far smarter to do so a year or two ago? Yeah, it's a mouthful to swallow. And nobody likes it. Did everyone think that the Chinese were going to pour their billions into our housing market forever while huge areas of our economy lagged behind in the 20th century? Were we going to buy oil from the Arabs forever while shipping our jobs overseas? Were we going to borrow from the future forever?

Okay, any readers still left are probably not Republican. So let's get down to business. I've been reading Paul Krugman, Berkeley economist Brad DeLong and others trying to understand the economic crisis. Krugman and DeLong have been very useful but I also found an interesting article on The Oil Drum that does a good job of sizing up the situation. Let me show a graph from the article first:

As simply as I can put it, the higher up the blue line is, the more deeply we're in a credit crisis. The left side of the graph represents 2006 through about April 2007. In that period, the credit markets weren't great but they were relatively normal and stable. Then things started happening. The weird moment occurs in July 2007 when the credit markets look as if they're settling down (where the trough is) after some trouble in June 2007. But July 2007 is the moment when the foot traffic in mortgage companies stopped and many banks suddenly got nervous (or broke out in sweat). It took two or three weeks for the credit crisis to show up on the graph where suddenly it goes sky high. What follows after is the turbulence of the markets. Graphs can give you an idea of what's happening but when there's lots of turbulence, it starts getting very difficult to read what's happens next. There's a spike in late March of 2008: that's the Bear Stearn meltdown. And the skyrocketing line on the far right: that's now and it scares Krugman and a lot of other economists.

Here's the article and two important points:
...the most notable thing over the past year has been the general mistrust amongst banks, and their reluctance to lend to one another.


• The players that had low risk, low cost funding, high volume investment strategies are stuck as the low cost bit has disappeared; they have to stop their business; some have come to trouble in the process, but this is a liquidity issue and they might be saved by central bank intervention;

• those that had high risk, low cost funding, high(er) returns are quite dead as the high risks happen to have been (really) bad risks. The disappearance of low cost funding is, to a large extent, irrelevant to their situation.

The trouble is that the two cases are often hard to distinguish....

By the way, the article mentions the LIBOR, a daily index of international interest rates in different currencies. I didn't know what the Libor was until a friend, BT, sent me the article ten days ago. The subject is arcane but the article is well written.

The Oil Drum article leads to a number of other articles worth reading. Here's an excerpt from an article in the Financial Times:
If lenders demand huge spreads for such short periods, they are either tightly constrained in their ability to lend, deeply concerned about the solvency of counterparties, or engaged in predatory behaviour. Whichever of these possibilities is true, credit to the economy will dry up. If banks do not trust banks, what do they trust? The answer is: only the government.

In the U.S., the government is George W. Bush. Obviously Congress legislates and the Democrats have vastly improved on the ridiculous bill Bush originally sent them but it is Paulson and others who will physically handle the bailout. Obviously we have a problem for the remaining four months of Bush's presidency.



Anonymous S.W. Anderson said...

Re-regulation and a whole lot of reforms are needed, just as fast as can be arranged.

For starters, outlaw adjustable-rate mortgages. My dad was a banker. He was for years the bank's mortgage and small-business loans officer. He and his bank were so ethical and cautious they squeaked — for a reason. Because there were still people in the small city I grew up in, in the 1940's and 1950's, who still wouldn't put a cent in a bank, recalling the nightmare of 1929-1931.

ARM's are what my dad would've called a "come on," sucker bait, in other words. Had they been available when he was handling mortgages, I'm sure he would've said and done everything in his power to discourage his bank from offering them, or failing that, he would've discouraged customers from signing up for them.

For a good second move, outlaw derivatives or derivatives trading.

For a third, require that hedge funds be subject to the same transparency rules and the same regulatory requirements as mutual funds.

For a fourth, play hell with the practice of bundling and selling off mortgages and other such loans. Maybe require the original lender to hold the contract for not less than a certain period of time, no matter what. Then, when the lender can sell loan contracts, make him submit the loan and any others (bundles), along with terms of the selloff deal, to bank auditors for review — for a fee. At the same time, require the prospective seller to notify all affected parties by registered mail,and keep records verifying that has been done.

I could go on, but you get the idea: I want the "heavy hand" of government regulation to weigh the greedy bastards down to the point they can no longer play fast and loose, leaving the rest of us to pay up and clean up the messes they make, while they stuff their ill-gotten gains into false-front corporate headquarters in the Caribbean and banks in places like Dubai.

9:59 PM  
Blogger Craig said...

S.W., my father was in the chemical packaging business in Los Angeles and was responsible for getting and administering various contracts. The business community in L.A. could be really cutthroat at times but the bigger companies worked hard to protect their integrity. I had a chance close-up to watch my father interact with an older generation of businessmen (and 1 businesswoman, a true rarity) who were my father's customers and who were usually honest and straightforward. They became friends of my family and I knew them into their old age. I suspect they had learned a great deal from the corruption of the 20s and the struggles of the 1930s. They knew how corrosive dishonesty and loss of trust can be. They appreciated the money they made but they had a strong sense of responsibility.

To be truthful, my father's generation often wasn't quite as honest. I'm not quite sure what the dynamics were, though I slowly figured out that my father wasn't perfect but he knew his business well and could afford to be one of the more honest ones in a very difficult environment (if my father fudged on business matters, and my mother found out, she was on him in a second; in nonbusiness situations, my father could be honest in ways that surprised me).

Then my father reached an age where he became a consultant and he had to deal with a number of younger associates from different companies. They were often not much better than crooks in executive suits and he had to watch them like a hawk. Unfortunately these were the people he had to deal with and get past if he was going to stay in business. The biggest problem is that they kept trying to steal his business contracts (his long-time customers usually tipped him off). Once, in my early thirties I was visiting my parents over a three-day weekend though they had plans one evening. About an hour after my parents left, an associate showed up and tried to weasel himself upstairs so he could go through my father's papers. I sent him on his way. My father eventually severed that relationship.

There have always been crooks and there have always been reasonably honest people but I'm convinced there's been a change in the last fifty years where crookedness or perhaps 'ruthlessness' is more acceptable. One thinks of the 'me' generation. The one that said 'greed is good' (which I suppose by now includes two or three generations).

In the 1980s, a younger cousin showed me a business script for cold calls that was deliberately manipulative and deceitful. The company? Merrill Lynch. Look where they are now. Unfortunately, such practices have become quite common.

My wife and I have a friend who was fired from a bank a year ago. She wasn't fired for being dishonest. She was fired for being too honest.

Yeah, we need reform all right.

And somebody ought to figure out how to bring the honest ones back into the banking and investment sector.

Thanks for the comment. You've stirred up some memories.

1:11 AM  
Anonymous Anonymous said...

I was looking at the graph and wondering just when the gas prices started going up. Wasn't it about the time the line starts going up?
Could it be that as more money was needed for gas, it collapsed tight budgets and those that believed in credit just charged it.


6:03 AM  
Anonymous S.W. Anderson said...

Craig, I've seen and heard and read about things since the early 1980s that would've been unimaginable in the 1950s and, I think, in the 1960s. Everything you relate rings true.

There are always honest, decent people in business and in the workplace. There are always some so bad they're actually criminals.

Perhaps the most scary component is an uncertain number of people with a loose grip on honesty and integrity. When circumstances are favorable and those around them are behaving, these people mostly behave well also. But when the going gets rough, when others are lying, cheating and stealing, they will readily do likewise. The standard line seems to be, "Everyone else is doing it, and I have to . . . keep my job . . . be able to compete . . . yada, yada, yada."

4:16 PM  

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