9-19-08 Crisis End Game--Paul Krugman NY Times
Op-Ed Columnist Crisis Endgame By PAUL KRUGMAN Published: September 18, 2008
On Sunday, Henry Paulson, the Treasury secretary, tried to draw a line in the sand against further bailouts of failing financial institutions; four days later, faced with a crisis spinning out of control, much of Washington appears to have decided that government isn't the problem, it's the solution. The unthinkable - a government buyout of much of the private sector's bad debt - has become the inevitable. Skip to next paragraph
Paul Krugman Readers' Comments
Share your thoughts on this article.
* Post a Comment » * Read All Comments (75) »
The story so far: the real shock after the feds failed to bail out Lehman Brothers wasn't the plunge in the Dow, it was the reaction of the credit markets. Basically, lenders went on strike: U.S. government debt, which is still perceived as the safest of all investments - if the government goes bust, what is anything else worth? - was snapped up even though it paid essentially nothing, while would-be private borrowers were frozen out.
Thus, banks are normally able to borrow from each other at rates just slightly above the interest rate on U.S. Treasury bills. But Thursday morning, the average interest rate on three-month interbank borrowing was 3.2 percent, while the interest rate on the corresponding Treasuries was 0.05 percent. No, that's not a misprint.
This flight to safety has cut off credit to many businesses, including major players in the financial industry - and that, in turn, is setting us up for more big failures and further panic. It's also depressing business spending, a bad thing as signs gather that the economic slump is deepening.
And the Federal Reserve, which normally takes the lead in fighting recessions, can't do much this time because the standard tools of monetary policy have lost their grip. Usually the Fed responds to economic weakness by buying up Treasury bills, in order to drive interest rates down. But the interest rate on Treasuries is already zero, for all practical purposes; what more can the Fed do?
Well, it can lend money to the private sector - and it's been doing that on an awesome scale. But this lending hasn't kept the situation from deteriorating.
There's only one bright spot in the picture: interest rates on mortgages have come down sharply since the federal government took over Fannie Mae and Freddie Mac, and guaranteed their debt. And there's a lesson there for those ready to hear it: government takeovers may be the only way to get the financial system working again.
Some people have been making that argument for some time. Most recently, Paul Volcker, the former Fed chairman, and two other veterans of past financial crises published an op-ed in The Wall Street Journal declaring that the only way to avoid "the mother of all credit contractions" is to create a new government agency to "buy up the troubled paper" - that is, to have taxpayers take over the bad assets created by the bursting of the housing and credit bubbles. Coming from Mr. Volcker, that proposal has serious credibility.
Influential members of Congress, including Hillary Clinton and Barney Frank, the chairman of the House Financial Services Committee, have been making similar arguments. And on Thursday, Charles Schumer, the chairman of the Senate Finance Committee (and an advocate of creating a new agency to resolve the financial crisis) told reporters that "the Federal Reserve and the Treasury are realizing that we need a more comprehensive solution." Sure enough, Thursday night Ben Bernanke and Mr. Paulson met with Congressional leaders to discuss a "comprehensive approach" to the problem.
We don't know yet what that "comprehensive approach" will look like. There have been hopeful comparisons to the financial rescue the Swedish government carried out in the early 1990s, a rescue that involved a temporary public takeover of a large part of the country's financial system. It's not clear, however, whether policy makers in Washington are prepared to exert a comparable degree of control. And if they aren't, this could turn into the wrong kind of rescue - a bailout of stockholders as well as the market, in effect rescuing the financial industry from the consequences of its own greed.
Furthermore, even a well-designed rescue would cost a lot of money. The Swedish government laid out 4 percent of G.D.P., which in our case would be a cool $600 billion - although the final burden to Swedish taxpayers was much less, because the government was eventually able to sell off the assets it had acquired, in some cases at a handsome profit.
But it's no use whining (sorry, Senator Gramm) about the prospect of a financial rescue plan. Today's U.S. political system isn't going to follow Andrew Mellon's infamous advice to Herbert Hoover: "Liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate." The big buyout is coming; the only question is whether it will be done right.
Warren Buffett Pessimistic About Economy 6-25-08 AP
The Oracle of Omaha says head for the bomb shelters!
OMAHA, Neb. (AP) -- Billionaire Warren Buffett has
already said he thinks the U.S. economy is in a
recession, and now he says the economy is getting
Buffett told CNBC in a live interview Wednesday
that all the data he sees from Berkshire Hathaway
Inc. subsidiaries shows the economy weakening.
"Everything connected with construction and with
consumer, I see weakness, and if anything, it's
accentuating a little bit."
Buffett also said he thinks inflation is picking
up, especially in steel and oil, so it should be a
concern for the Federal Reserve.
George Soros is Not Optimistic on Market Outlook 4-11-08
"I consider this the biggest financial crisis of my lifetime," Mr. Soros said during an interview Monday (4-7-08) in his office overlooking Central Park. A "superbubble" that has bee swelling for a quarter of a century is finally bursting."
Here's a link to Louise Story's fascinating article about Soros in today's NYTimes.
6-26-08 Fed Signals No More Rate Cuts Louis Uchitelle in the NYTimes
How Did We Get in This Mess?
3-19 How Did We Get In This Mess? David Leonhardt explains
in a short article in today's N.Y.Times
"...It really started in 1998, when large numbers of people
decided that real estate, which still hadn't recovered
from the early 1990s slump was a bargain. At the same time,
Wall Street was making it easier for buyers to get loans.
It was really 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 competition brought down mortgage fees and spurred
innovation, much of which was undeniably good. Why should
someone who knows that they're going to move after
just a few years have no choice but to take 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:
"Because these loans to to people stretching to afford
a house, they come with higher interest rates--even
if they're disguised by low initial rates--and 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 only appeared
in this newspaper only three times before 2005, but 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
strategy around. They made $100 million bets with only $1
million of their own money and $99 million in debt. If the
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...."
March 18--The Dow was up 420 points or 3.5% on the expectation of a big Fed interest rate cut.
The Fed cut it's short term rate by 3/4 point , the highest single day-cut in a long time.
Some had expected a full point cut. It will be interesting to see what the stock market does
March 18 The failure of Bear Stearns and its rescue by the Fed and JP Morgan Chase may well be the first rather than the last bank failure. The market is up today, but it's not clear at all that the worst is over. There is a good possibility of more bad news to come.
Feb 12-Shoes Continue to Drop
According to a fron page article in today's NYTimes, the mortgage crisis has spread beyone subprime
loans and is now pinching people with good credit, "sucking in all borrowers" according to Matt Zandi, chief economist at Moody's economy.com. ...economists say that rate cuts and the $168 billion stimulus
package are unlikely to make a significant dent in the large debts weighing on many Americans, because
banks have tightened lending standards and expected rebates from the government will not cover most house payments...as a result more borrowers appear to be giving up on their homes as prices fall "noting a change in social attitudes toward default."
On a more positive note, slightly more than a third of American homeowners have paid off their mortgages completely. The NYT article by by Vikas Bajaz and Louise Story is linked below.
A headlined article on the NYT front page of the business section reads "Bad Bets and Accounting Flaws
Bring Staggering Losses (to hedge funds)
Jenny Anderson reports that this will be the year with the highest number of hedge fund failures given the huge number of new and untested hedge funds, according to Bradley Alford, founder of Atlanta-based
Alpha Capital Management. Anderson's article is linked below.
Meanwhile the inventive wizards of Wall Street have recently invented an entirely new financing concept called SPACS, short for Special Purpose Acquisition Companies earlier called "blank check companies." SPACs sell shares to raise money for an unspecified one big acquisition which they must make within 18 months or return the money, less expenses, of course. Anyone interested in being SPACked can read an article by Andrew Ross Sorkin linked below.
Credit Crisis Spreads Beyond Subprime Mortgages
A Bad Year for Hedge Funds by Jenny Anderson
Are You Ready to be SPACked?
Federal Reserve Cuts Key Rate by 1/2 Percent
Wednesday afternoon, January 30, the Federal Reserve announced a half-point cut, bringing the Fed Funds rate to 3 percent. This comes on top of the 3/4 point cut announced last week, indicating continuing concern about the economic outlook.
Fed Rate Cut Report by Edmund Andrews in the NYTimes
Joe Nocera's column will spoil your weekend! 1-26 NYT
- Hate to Spoil A Weekend, But.....
More write-downs yet to come. End to a 25-year cycle?
More Shoes Drop in New York and Paris
Two big bond insurance companies are in big trouble stemming from the subprime mortgage fiasco. See linked NYTimes story below.
The biggest drop in existing home sales reported. See link below.
One of France's largest banks, Societe Generale, reported $7.1 billion loss due to a secret rogue trader's speculation with the banks's money in European index derivatives. More on this linked below.
Two Big Bond Insurers are In Big Trouble
Biggest Drop in Home Sales in 25 Years
Society Generale Reports $7.1 Billion Loss
Markets down in Europe and Asia--NYTimes 1-21-08
1-21-08 Stock Markes Plunge 7% in Europe and Steeply in Asia on Fears of U.S. Inflation
"There is indeed some panic" said Thomas Mayer, chief european economist of Deutsche Bank in London..
Stock Market Down 300 Points 1-17-08
The Dow plunged 300 points and other averages declined as well as markets reacted to continuing bad news stemming from the subprime mortgage fiasco. Congress and the President are considering steps to reduce the depth of what now nearly everyone predicts will be or already is a recession in the United States. Fed Chairman Ben Bernanke told a House of Representatives committee that he supports an "explicitly temporary" infusion of cash into the economy in the form of tax rebates of possibly $80 billion. He said that measures to forestall or shorten a recession are a separate issue from making the Bush tax cuts permanent or allowing them to expire. Other measures might include increasing the level of Unemployment Compensation payments and extending the benefits beyond 26 weeks. A provision for accelerated depreciation of capital equipment purchases, proposed by Republicans is also under consideration. Everyone agrees that measures must be undertaken ASAP if they are to have a chance of avoiding or shortening a recession this year.
Stock Outlook for 2008 Unclear
U.S. and most world stock indexes ended up for 2007, but the outlook for 2008 is uncertain as additional developments in the subprime mortgage crisis continue to unfold. Here's an article from the 1-1-08 NYTimes linked below.
Bad Start--down 1.4%--Recession Near? Floyd Norris NYT 1-2-08
Market Outlook Uncertain [As usual!]
Floyd Norris says "As in 'Its a Wonderful Life,' it may take a guardian angel to solve the mortgage crisis."
Bad News from Fed is Good News for Stocks
The Dow soared 316 points today following remarks by Federal Reservef Vice Chairman, Donald Kohn, which ingited investor hopes for an interest rate cut in December. Kohn pledged that the Fed would "follow flexible and pragmatic policy making" and "act as needed" in dealing with current volatile economic conditions. "Uncertainties about the economic outlook are unusually high," he said.
Stocks Soar on Fed Vice Chairman's Remarks 2:45 pm Nov 28
CitiGroup in Deeper Trouble Than Previously Acknowledged 11-27
Yesterday there was another indication that the CitiGroup's predicament and that of other banks exposed to the subprime mortgage fiasco is worse than previously admitted. Yesterday CitiGroup announced a $7.5 billion capital injection from the Abu Dhabi Investment Authority in return for a 4.9% equity stake in the bank. Whether or not this cash injection will be sufficient for CitiGroup to pull out of the deep hole which it has dug for itself, only time will tell. Moreover, it gives cause to wonder how many other institutions are similarly vulnerable, institutions who are not in a position to tap into Middle East oil money for a bailout. ???
Having had unsatisfactory personal experience with a CitiGroup credit card and watched an incredibly obtuse and arrogant representative of the bank testify before a Congressional committee investigating credit card "tricks and traps" for the unwary, I can't gin up much sympathy for the bank's current troubles.
Continuing Uncertainty Over How Much More Bad News is Yet to Come Resulted in Another Sharp Decline in Stocks on Monday Nov. 26
Investors bailed out of stocks again today and bought Treasury bonds because they fear more bad news stemming from the subprime mortgage fiasco and resulting credit crunch.
The Dow was down 237 points or 1.8% and the Nasdaq fell 2.1%.
The Wall Street Journal reported that Citigroup's accountants are debating over whether additional $41 billion of mortgaged-back securities onto it's balance sheet on top of the $21 billion hit it has already taken. Whether or not Citigroup takes the additional hit this year, the black cloud isn't likely to evaporate.
The Week Starts off With Another Downer in the Stock Market
An Ugly Week for Investors Michael Grynbaum in the NYT
Stocks plummeted to their lowest level since April in another ugly week for investors who remain frightened by continuing credit crisis. Michael Grynbaum's report in today's NYTimes (11-22) is linked below.
Ugly Thanksgiving Week for Investors
Another subprime casualty--Freddie Mac 11-20
from The Wall Street Journal
Freddie Mac's net loss for the third quarter more than doubled to $2.03 billion on higher credit-loss provisions and the marking to market of securities, reflecting housing-market weakness and the deterioration of mortgage credit. The home-loan investor said the fair market value of its net assets fell by $8.1 billion in the quarter. Freddie Mac has hired an adviser to study capital-raising options and said it is considering cutting its dividend by half. The shares fell 6% in premarket trading.
[Comment: in this observer's view we're nowhere near the end of the bad news.]
New Worries About Credit Drive Stocks Down by Michael Grynbaum NYT 11-20-07
Subprime Credit Crisis Affects Money Market Funds
Floyd Norris Explains What's Happening to the Stock Market and Credit Markets
In a long article the NYT's senior financial writer, Floyd Norris, comments on what's happening to the stock market, credit market and the housing market.
Suddenly it's not so easy to borrow. That's true for home owners, and its true for companies.
"That is the core of a financial crisis, when too many peo0le head to the exits simultaneously," said Robert Burner the dean of the business school at the University fo Virginia.
Investors bought mortgage and other loans thinking they were completely safe, and some did so with borrowed money....The markets are very paniced and illiquid. Its very difficult to find buyers even for AAA securities....The real problem is that lenders and investors fear things will get much worse. "This is what we would characterize as the first correction of the modern neo-credit market", sad Mr. Malvey of Lehman Brothers. "We've never had a correction with these types of institutions and these types of instruments."
"Financial panics don't happen during depressions," said James Grant, the eidtor of Grant's Interest Rate Observer. "They happen on the brink of depressions."
Not all panics lead to economic downturns, and if this one continues pressure will grow on the Fed and other central banks to lower the short-term interest rates they control and thus stimulate the economy.
But central banks do not always determine what happens in credit markets.
Here's a link to Floyd Norris's article.
What's a Fed Chairman to Do? Alex Berenson in NYT 8-5.2007
"The fine line between creating a bubble and risking a slowdown."
Mortgage Mania Didn't Grip Everyone by Gretchen Morgensen in NYT 8-5-07
The seized-up U.S. mortgage market claimed more victims both here and abroad last week. The American Home Mortgage Investment Corporation, once a big lender, closed its doors, laying off more than 6,000 workers. In Germany, IKB Deutsche Industriebank received a $4.8 billion bailout from a government-owned group that said it would cover potential subprime losses at the bank.
In a report last week, Charles Peabody, an analysy at Portales Partners, an independent research firm in New York, characterized the state of the mortgage market this way: "Investors finally realized that there is such a thing as a bad mortgage loan. As a matter of fact, there is such a thing as a whole bunch of bad mortgage loans."
As a result, Mr. Peabody noted, investors are no longer interested in most of the risky loans that mortgage bankers have been creating lately. Bankers can sell only the highest grade pieces of those wonderful securities pools that were so popular among investors until about five minutes ago.
Michael Farrell, CEO of AnnalyCapital Management, is an excellent person to consult on what is likely to happen next.
Annaly is an investment management company that oversees a a portfolio of strictly high grade assets. The company invests solely in mortgages backed by government-sponsored entities like Fannie Mae, Freddy Mac and Ginnie Mae. Investors understand that it has little exposure to the current credit crunch and have bid up its shares almost 8 percent this year. The shares also pay a generous dividend of 6.4 percent at current prices.
"I look at this sort of like 1990 and 1991," Farrell said, "referring to the savings-and-loan cricis. "Against that backgfound you had a $7 trillion economy that gave birth to the $300 billion Resolution Trust Corp. Now we have an $11 trillion economy and we've already seen $2 trillion of market capitalization going away" before many loans in the pools have actually defaulted, he said.
What about the people who argue that the impact of the morthgage mess will be muted because risks have been spread well beyond the banks and into many parts of the financial world? Mr. Farrell takes the opposite vbiew. Spreading the risk beyond the banking wywstem will make the task of fixing the mess much harder.
"Even if the Fed eases, it is probably not going to help the housing market," he said. "This repair cycle is going to take a lot longer because it is not concentrated in the banking system like it was in the 1190s. Back then, they could repair the banking system by dropping interest rates. Now they can't bail out rich hedge fund guys in Greenwich."
Subprime Home Mortgage Crisis
Wall Street Ends Volatile Session Higher; CitiGroup Emergency Board Meeting
Hedge Fund Incentives Work Against Investor Interest
More by this Author
Bob Dylan's songs protesting the Vietnam War and the Cold War are my earliest and strongest memories of Dylan. They are among the most powerful protest songs in the history of American music. "A Hard Rain's a...
Have a little fun with Ann Coulter here.
Staph Infections Patients who have sores that will not heal or that are filled with pus should see a doctor and ask to be tested for staph infection. They should not squeeze the sore or try to drain it--that can spread...