19 February 2008
Head Seeking Sand
Posted by Joy Bischoff under: World Economy .
Am I dense? Have I not noticed the ostrich tendencies, the empty comments section when I post stories on the economy? Actually, I have. Will I stop posting them then? No. Here are selected portions of a disturbing article:
America’s economy risks the mother of all meltdowns
By Martin Wolf Tue Feb 19, 1:25 PM ET
… So how bad might this downturn get? To answer this question we should ask a true bear. My favourite one is Nouriel Roubini of New York University’s Stern School of Business, founder of RGE monitor.
Recently, Professor Roubini’s scenarios have been dire enough to make the flesh creep. But his thinking deserves to be taken seriously. He first predicted a US recession in July 2006*. At that time, his view was extremely controversial. It is so no longer. Now he states that there is “a rising probability of a ‘catastrophic’ financial and economic outcome”**. The characteristics of this scenario are, he argues: “A vicious circle where a deep recession makes the financial losses more severe and where, in turn, large and growing financial losses and a financial meltdown make the recession even more severe.”
… Here are his 12 - yes, 12 - steps to financial disaster.
Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000bn and $6,000bn in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.
Step two would be further losses, beyond the $250bn-$300bn now estimated, for subprime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had “reckless or toxic features”, argues Prof Roubini. Goldman Sachs estimates mortgage losses at $400bn. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks’ ability to offer credit.
Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The “credit crunch” would then spread from mortgages to a wide range of consumer credit.
Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150bn writedown of asset-backed securities would then ensue.
Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.
Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.
Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps“, which insure such debt. The losses could be $250bn. Some insurers might go bankrupt.
Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.
Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.
Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.
Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”.
…” This, he suggests, is the “nightmare scenario” keeping Ben Bernanke and colleagues at the US Federal Reserve awake. It explains why, having failed to appreciate the dangers for so long, the Fed has lowered rates by 200 basis points this year. This is insurance against a financial meltdown.
Is this kind of scenario at least plausible? It is. Furthermore, we can be confident that it would, if it came to pass, end all stories about “decoupling”. If it lasts six quarters, as Prof Roubini warns, offsetting policy action in the rest of the world would be too little, too late.
Can the Fed head this danger off? In a subsequent piece, Prof Roubini gives eight reasons why it cannot***. (He really loves lists!) These are, in brief: US monetary easing is constrained by risks to the dollar and inflation; aggressive easing deals only with illiquidity, not insolvency; the monoline insurers will lose their credit ratings, with dire consequences; overall losses will be too large for sovereign wealth funds to deal with; public intervention is too small to stabilise housing losses; the Fed cannot address the problems of the shadow financial system; regulators cannot find a good middle way between transparency over losses and regulatory forbearance, both of which are needed; and, finally, the transactions-oriented financial system is itself in deep crisis.
The connection between the bursting of the housing bubble and the fragility of the financial system has created huge dangers, for the US and the rest of the world. The US public sector is now coming to the rescue, led by the Fed. In the end, they will succeed. But the journey is likely to be wretchedly uncomfortable…
*A Coming Recession in the US Economy? July 17 2006, www.rgemonitor.com; **The Rising Risk of a Systemic Financial Meltdown, February 5 2008; ***Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not.
15 Comments so far...
Chuck C Says:
19 February 2008 at 7:13 pm.
What do you think we should do, get out of debt?
Bad Debt » Blog Archive » Head Seeking Sand Says:
19 February 2008 at 7:37 pm.
[…] Read the rest of this great post here […]
Credit Cards on The Finance World For News and Information Around The World On Finance » Head Seeking Sand Says:
19 February 2008 at 7:59 pm.
[…] Head Seeking Sand Am I dense? Have I not noticed the ostrich tendencies, the empty comments section when I post storie […]
Joy Bischoff Says:
19 February 2008 at 8:26 pm.
Gee, Chuck, I think that’s a mighty fine idea. Get out of debt, put up some food and water, get a three day emergency kit…hmmm, something tells me we would be wise to do that 
.
And thanks for not leaving the comment section blank this time.
Carrie Says:
19 February 2008 at 8:37 pm.
Joy,
I am so thankful for my parents. They have done all that so I know I have a soft place to land when I need it. I know this is kind of scary but I think it is smarter to get ready and face up to things. So keep it up.
SGS Says:
19 February 2008 at 8:51 pm.
Joy, it is unfortunately that your economy posts have been empty so far. It is a difficult topic for many Americans to understand, leave alone discussing. To be fair with you, I do enjoy discussing the economy. But I am only a beginner when it comes to economy, regardless of my many years of investing, a several house purchases under my wing and quite a few articles I have read.
Let me see if I get the gish of what you (or rather Martin here) are saying. Think of the economy as a flow, that is: We buy the products which will result in the companies having the money to pay its employees. The employees bring the money home, and we are back to point A. I know this is a very simple model, but bear with me. The problem as I understand it is that we Americans on average are spending more than we are earning (taking out our equities, zero saving rates, low retirement funds — if any). As such, we will end up with no money to spend. The companies suddenly find themselves unable to find customers who can afford to buy their products or services. The companies then do not have the money to pay their employees, so they will have to borrow some to carry them over the rough period (many of them do it during the recession periods). But, many of the lenders already are struggling to break even on their reckless loans (mortgages, credit cards, etc…) Many of them may file bankrupts within next few years, especially if the Federal Government do not bail them out. Because these lenders do not have cash readily on hand, they won’t be able to lend money to the companies. The companies will have to let go many of their employees. And we are back to point A, where even more of us Americans do not have cash to spend.
Is this the gish of what Martin is trying to say, that every point in our economy is already strained out, that there won’t be a point, be it us consumers with our negative saving rates, the companies, the lenders, or the deep-red Federal Government, that could jump-start the whole cycle?
Joy Bischoff Says:
19 February 2008 at 11:27 pm.
SGS, apparently you understand more than you think. That was a good nutshell of the problem. What complicates it even more is the same thing that happened in Germany that had the citizens there so frightened that they welcomed a savior who turned into a monster. Their currency became devalued.
Because of our lending crisis, interest rates are being lowered to ease the credit crunch. Now our dollar buys a lot less than it did a year ago although paychecks have not gone up. We are buying less so companies are unable to find customers for enough of their product, as you said above for this additional reason also. Every time the interest rate is lowered, our dollar is weakened. We gain short-term benefits for long-term consequences. It is a bandaid.
Here is the scary part. Our national debt is being bought up by foreign investors. America is more than half owned by people with no loyalty to our national sovereignty. The new gold is oil and OPEC is threatening to back oil with the Euro and not the dollar because the dollar is so weak. If this happens, the dollar will devalue drastically and it will be a matter or time until it collapses as foreign investors dump their weak dollars. They hold our economic well being in their hands.
Cavetrollhead Says:
19 February 2008 at 11:37 pm.
I have to admit, I am a big dummy in economics. I couldn’t even finish this article because it was speaking Greek to me. But let me give some advice that even a dummy can give and a dummy can receive.
Get a years supply of food storage that is cycling. (this means you are eating the oldest stuff first and replacing it constantly with newer stuff so that it alway equals at least one year.
Get a couple of months of Water storage.
Get out of debt. Pay off your house. DON’T GO AFTER A TAX WRITE OFF FOR MORTGAGE INTEREST UNLESS YOU ARE SURE YOU WILL BE DEAD BEFORE YOU PAY OFF YOUR HOUSE!
Buy a FUEL powered AC generator.
Buy a gun.
Learn to garden.
Call me Noah, laugh at me - I don’t care. If you are prepared you will not fear. Fools will mock but they shall mourn.
Cavetrollhead Says:
19 February 2008 at 11:47 pm.
SGS I think you explained it better than that article did. What in the world is a “credit default swap,” a “fat tail” and “shadow financial system?” I mean I know what a Fat Tail is but what is a Fat tail? A fox has a fat tail. A shadow financial system? Is that the black market? JK
Please don’t tell me- I don’t really want to know. Just a rhetorical question to illustrate why the average Joe like me doesn’t get the macro economy- The pros trying to teach me are speaking . . .well it isn’t English and it isn’t Russian.
Joy Bischoff Says:
19 February 2008 at 11:58 pm.
Cave, you have the important stuff down cold. The advise you gave is the key.
Chuck C Says:
20 February 2008 at 12:10 am.
Cave, can I stay with you when this all hits?
Cavetrollhead Says:
20 February 2008 at 12:20 am.
Anytime Chuck. You will be treated like family.
Stumpy Says:
20 February 2008 at 12:22 am.
Chuck you come on over to my place. Its humble but it aint no cave. Besides I need help with the milking and y’all were a scraped up little cow boy once upon a time so you will do. Ever shot a jackrabbit?
Sharon Anderson Says:
20 February 2008 at 12:58 am.
By the way, recent reports show that many food storage items like rice, oats and wheat, last much longer than previously thought (even 30 years). So if you haven’t rotated it and have had it a long time, you still might want to keep it.
Here is the report:
“New Findings for Longer-Term Food Storage”
Findings of recent scientific studies conducted by a team of researchers at Brigham Young University show that properly packaged, low-moisture foods stored at room temperature or cooler (75°F/24°C or lower) remain nutritious and edible much longer than previously thought. The studies, which are the first of their kind, increase the estimated shelf life for many products to 30 years or more (see chart for new estimates of shelf life). Previous estimates of longevity were based on “best-if-used-by” recommendations and experience. Though not studied, sugar, salt, baking soda (essential for soaking beans), and vitamin C in tablet form also store well long-term. Some basic foods do need more frequent rotation, such as vegetable oil every 1 to 2 years.
While there is a decline in nutritional quality and taste over time, depending on the original quality of food and how it was processed, packaged, and stored, the studies show that even after being stored long-term, the food will help sustain life in an emergency.
http://www.providentliving.org/content/display/0,11666,7797-1-4222-1,00.html
SGS Says:
20 February 2008 at 12:34 pm.
Cave, the sad part about food storage at the present time is that there have been quite a few crop wipe-outs around the world, so the cost of wheat, rice and other few long term samples have increased greatly. Most of us would have been better off buying the food storage when we were encouraged to do so, rather than doing it now. With the cash crunching, many of us will be able to afford even less. I am glad we have used the tax refunds and bonuses in the past to stock up on our food storage. But we have not extend to guns, generator and others. I’d like to, but with my starting a business, we do not exactly have the ready cash on hand. It’s definitely on top of our list.
Leave a Reply
You must be logged in to post a comment.