Summary: The Paulson Plan is already irrelevant. New and larger measures are needed immediately. This post considers their size and scope. We are only weeks away from disaster. Fortunately, I am certain that Secretary Paulson and Chairman Bernanke know this. Bernanke, as an expert on the Great Depression, certainly understands the need for fast and effective action.
The end of the post-WWII debt supercycle started with the collapse of the mortgage brokers in December 2006. Since then the government has made aprox 15 initiatives to stop the deterioration of our financial system. The super SIV, 3.25% in cuts to the federal funds rate, FHA Secure, Hope Now, a $120 billion tax rebate, massive expansion of access to the Fed’s discount “window”, TAF auction, TSLF, PDCF, the Bear Stearns bailout, the nationalization of the GSE’s and AIG … and now the TARP (aka the Paulson Plan). Don’t bother looking up the acronyms, they will all soon be forgotten.
All too small, too late. Incremental and reactive, responding to critical problems of last month — irrelevant to the current situation. This is a recipe for disaster. Like in the US 1929-1933 and Japan 1989-1996 — delaying the necessary large-scale response until the problem was no longer manageable.
Now the US financial system is seizing up. The machinery remains, but the gears no longer turn. Most of you have no idea to what I am referring, but you will learn over the next few weeks. To use a bad medical analogy, the financial system has had a cardiac arrest. Rather than describe the problem, this post describes solutions.
What must be done now
Restarting the necessary flows through the business credit system must be done immediately, and will require drastic measures. The following indicate the broad scope and scale of the necessary action, not the specifics.
(1) Broad guarantees of the securities for the financial sector. Not just banks and brokers, but also leasing companies and lenders of every flavor. Confidence in these securities must be restored now.
The Paulson Plan is only a small first step in this direction. More is needed, fast. The Fed is pumping vast sums into the financial system (”Wall Street”), but the money is not reaching “Main Street.” Disintermediation is necessary.
(2) Direct lending to business. For example,
(a) Direct loans to corporations by the Fed (e.g., Fed purchases of commercial paper from companies).
(b) Fast loans from the Small Business Administration on simple security (personal guarantees and net assets of the business). As were made to families after Katrina.
The recession is coming, and the current financial crisis has exacerbated it. We should prepare for something longer and deeper than 1973-75 or 1980-82 (the worst since the 1930’s). Let’s not wait to begin mitigation efforts. Anyone asking “Dude, where’s my recession” should be banned from the Internet for life.
(3) Massive fiscal stimulus. Government spending on valuable infrastructure. Expanded education programs. Fast cash disbursements to local social service agencies. Avoid the usual chaotic rush — begin setting them up now, as their lead times are long. The alternative is dropping money from helicopters later.
This is triage. Immediate aid to those who can survive. Fairness and equity are now irrelevant luxuries. Punishment of the innocent and rewards to the guilty can wait until the immediate crisis has passed.
This is just first aid. The recession is coming. None of these measure will speed its end or lay a foundation for an economic expansion afterwards. Such measures must wait for the new Administration. The timing of the crisis, in the midst of a critical national election, could not be worse. Let’s hope our leaders can put aside their partisan differences to take the necessary steps. Let’s promise electoral death to those who cannot manage to do so.
I doubt we can take these measures without prior agreement of our creditors. The additional — and larger — measures necessary next year will certainly require their money, so let’s consult them now — rather than arouse anger by assuming their cooperation. For years they have provided vendor financing — loaning us the money to buy their goods. Now we ask them for much larger loans to mitigate the results of our past imprudence. Without their aid we cannot simultaneously obtain the necessary funds, keep interest rates low, and avoid a collapse of the US dollar.
This is one of the major inflection points of American history. The outcome will be shaped to a large degree by the skill and values of the new Administration. Please do all you can to help America make that decision. Donate your time and money. Get involved in discussions. Write and talk about it with everybody you know.
What should we do next, after applying First Aid?
That is a complex question. For a simple answer see the following (you will not like the answers):
- A solution to our financial crisis.
- America has changed. Why do so many foreigners see this, but so few Americans?
Other sources saying similar, if milder, things
- “From central bank to central planning?“, Prof Delong (Economic, Berkeley), BusinessDay, 29 September 2008
- “UC Berkeley economists think through the crisis“, San Francisco Chronicle, 2 October 2008
Esp note this: “Libor Rises, Commercial Paper Slumps as Credit Freeze Deepens“, Bloomberg, 2 October 2008 — Except:
The crisis deepened after the worst month for corporate credit on record. Leveraged loan prices plunged to all-time lows, short-term debt markets seized up and even the safest company bonds suffered the worst losses in at least two decades as investors flocked to Treasuries. Credit markets have frozen and money-market rates keep rising even after central banks pumped an unprecedented $1 trillion into the financial system.
“The credit window is closed,” Jim Press, president of Chrysler LLC, the third-largest U.S. automaker, said today at the Paris Motor Show. … “It’s going to get much, much worse,” said Gregory Peters, head of credit strategy at Morgan Stanley in New York. “The credit markets are effectively shut, the CP market, which there’s not enough focus on, is under complete duress. That can’t be sustained, as that’s the lifeblood of corporations funding themselves.”
Commercial banks and bond dealers borrowed $348.2 billion from the Fed as of yesterday, an increase of 60 percent from the prior week amid the worsening credit freeze.
The market for commercial paper plummeted $94.9 billion to $1.6 trillion for the week ended Oct. 1 as banks and insurers were unable to find buyers for the short-term debt amid the worst U.S. financial crisis since the Great Depression. Financial paper accounted for most of the decline, plunging $64.9 billion, or 8.7 percent, to a two-year low.
…”The purge is broad and is impacting issuers with far more predictable cash flows — regular run-of-the-mill companies in need of working capital,” Crescenzi wrote today in a note to clients. “The declines add to the urgency for fixes to the credit crisis and bolster the case for a Fed rate cut.”
The U.S. market for short-term debt backed by assets including mortgages and car loans fell $29.1 billion, or 3.9 percent, this week to a seasonally adjusted $724.7 billion, according to the Fed.
Originally published on Oct 3, 2008 at Fabius Maximus and reproduced here with the author’s permission.