The Slide Gathers Pace
I have been fully occupied writing so I have had no time to comment here for a while, but even I cannot avoid commenting on the sad state of the economy. The news today that Bear Stearns, a New York City investment bank, had to be bailed out by short term loans from J.P. Morgan Chase, a New York commercial bank, has sent shivers throughout Wall Street. Bear Stearns was a big player in the mortgage backed securities market and is now paying the consequences of its shoddy management and its fundamental misunderstanding of the risks it was taking. Here’s the latest from the New York Times:Bear Stearns Bailout Roils Stocks
Practically every piece of news now is bad: the dollar continues its slide against other currencies, particularly the Euro and the Yen. The American mismanagement of its currency over the past few years has been spectacular and leaves foreign investors little choice but to move their money into safer, stronger, currencies. Naturally the more people move the more pressure develops on the dollar creating a self-sustaining slide that could easily become a collapse if a bank like Bear Stearns failed completely.
One side effect of the dollar’s slide is that any product priced in dollar’s but produced in a non-dollar location gets more expensive for anyone who has to pay dollars for that product. That means Americans are going to pay a lot more for things like oil. This dollar effect is over and above the price inflation being caused by increasing worldwide demand. So American consumers are being hit twice, while other consumers [e.g. europeans] are mostly only paying for the demand inflation aspect of the rise in oil prices.
Years of economic mismanagement are coming home to roost!
The really nasty part of all this bad news is that it portends a long and deep recession. I don’t think anyone, other than George Bush and his cronies, really argues that America will now avoid recession. Indeed most analysts I know are saying we are under water already. What could make this recession lengthy is that the financial markets are in the epicenter.
For a bank like Bear Stearns to fail there has to be huge negative pressure in the markets. The process becomes a self-fulfilling prophecy: one bank demands that it is repaid cash it lent to another based upon collateral that has lost value. The second bank scrambles to find the funds to make the repayment. It makes demands of a third or fourth bank. They start to scramble too. And so on. A fully fledged panic can arise from nothing very quickly. This kind of instability leads even the most secure of banks to pull back from lending so that each can rebuild its capital and remain safe. The cascade of reduced lending and lost confidence consequently grinds the capital markets to a standstill. The result is that no one can borrow to expand their businesses and sooner or later the entire economy slumps.
That kind of scenario is being played out now. Not just Bear Stearns is in trouble: some lesser known hedge funds and investment houses are collapsing for lack of credit. Just this week Carlyle Capital, an offshoot of the notorious Carlyle Group, has been forced to liquidate itself to pay off its creditors. Other, smaller and private, organizations have already gone under.
Meanwhile large banks like UBS and Citibank are under enormous pressure because their investors no longer trust the portfolios of derivatives that still are being carried. The issue for both those banks is whether all their losses have been recognized or whether there are more write-offs yet to come. Given the continued collapse of the housing market, where all this trouble began, I seriously doubt that anyone can commit to a portfolio value that will stand the test of time for the next few months. So confidence will remain weak and values will fall as credit dries up.
The Federal Reserve Board is pulling out all the stops to plug the dyke. Unfortunately it is running out of tricks, and money. Lowering interest rates has had practically no effect: even after the last Fed Funds rate cut, which was dramatically large, other market rates, like those for mortgages, actually rose reflecting the growing panic on Wall Street. Lowering rates only works if someone is willing to lend at those lower rates! While all the banks are retrenching the willingness to lend is minimal.
So the problem will eventually have to be dealt with outside the market: Congress and the Administration will have to take action to rebuild confidence. Especially in the mortgage market where some form of regulation is now highly likely.
Let me state this bluntly: the current malaise is a shocking indictment of standard Republican economic policy, particularly that of laissez-faire. The simple fact is that to allow ‘market forces’ to run their course, as Bush and others on the right, have argued for months risks plunging the country over a precipice. No one can honestly forecast what would happen then. I doubt whether anyone wants to find out. Especially in an election year. So intervention will become the order of the day and the kind of ineffective voluntary actions advocated by Bush so far will quickly be replaced by legislation.
About time too: this storm has been gathering since late last summer. Since then Bush and his team have done nothing of substance to stem the tide. The report last week that American wealth had fallen back to its 2001 level just about sums up the Bush legacy: never before has a president presided over a zero wealth increase on his watch.
Still the good news is that the Reagan Republican era is being drawn to a close with its flaws fully exposed. Now comes the hard part: rebuilding with sensible and more balanced economic policies. For that we have to wait until after Bush leaves office. Meanwhile expect things to get ugly.
Or should I say “uglier”?
