The last opportunity for effective action before disaster strikes

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.

Situation report

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):

  1. A solution to our financial crisis.
  2. America has changed. Why do so many foreigners see this, but so few Americans?

Other sources saying similar, if milder, things

  1. From central bank to central planning?“, Prof Delong (Economic, Berkeley), BusinessDay, 29 September 2008
  2. 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.

One Response to "The last opportunity for effective action before disaster strikes"

  1. John Ryskamp   October 5, 2008 at 3:25 pm

    Hilarious. The problem with you is that you don’t know anything about the law, or you would know where to start.We start with a ban on all housing evictions. I have been advocating this for several years, and I wrote about its implications in my book, The Eminent Domain Revolt.Let me give you a little lesson in legal history: the reason we are in this disaster is that, in West Coast Hotel v. Parrish (1937), the Court set up the scrutiny regime. This regime is interpreted as meaning that, as long as a law is ‘rationally related to a legitimate government purpose,’ it is Constitutional. This is called minimum scruitny. Two consequences flow immediately from this interpretation:1. government has absolute power over facts; and2. individuals have no individually enforceable rights with respect to these facts.And look at you! YOU still want the power to distribute the goods, YOU still want the power to say who lives and who dies. You’re just a flunkey of the scrutiny regime.Now try to understand where we are going. We are in the process of junking the scrutiny regime. We have had several Constitutional regimes in the United States and I suggest you read the G. Edward White (Univ. of Virginia law school) essay, available online, entitled “Historicizing Judicial Scrutiny.”Your attempt to triage the facts hides the analysis you are undertaking. It is an analysis very familiar to the Supreme Court. The Court, in West Virginia v. Barnette, set down the standard for important facts and what happens to them, when it took exercises of religion OUT of the political system (that is, out of the hands of people like you) and turned them over to individuals.The Court said to focus on importnat facts. An important fact is a fact of human experience which, history shows, is not changed by attempts to change it. Exercises of religion, gender and racial legal equality, and protected speech are examples of facts which have passed this historical test.Once facts pass this test, they are removed from the political system, and power over them is turned over the individuals. In terms of the scrutiny regime, such facts go from enjoying minimum scrutiny to enjoying strict scrutiny. The test for a law affecting a fact enjoying strict scrutiny is that the law must be narrowly tailored to achieve a compelling government purpose. Basically, the survival of government has to be at stake for the government to attempt to affect such facts, because otherwise the law is considered to be unenforceable. Example: the existence of the state can only be preserved by interfering with an exercise of religion. Obviously, very few laws are ever sanctioned with respect to facts enjoying strict scrutiny.So what is the new regime? Even in West Coast Hotel–which sustained a minimum wage law–the Court said that it was allowing the law because it assisted in the “maintenance” of income. income is obviously an important fact for the Court. Nor did the Court say that law could have any other purpose besides maintenance.That this case has been interpreted as granting unbridled discretion for the political system, is the defining aspect of the corruption of the last seventy years.But the Court really meant it. Even in another famous case–Berman v. Parker, which seemed to give government the unlimited right to use eminent domain–the law was sustained because it assisted in the “maintenance” of the facts in that case.Obviously, we are now in an era in which strict factual analysis of what constitutes “maintenance” is being implemented. Your comment is a primitive example of it.What facts has public opinion concluded, are also important facts? Maintenance, housing, medical care and education. We are now in a new Constitutional regime, the “maintenance” regime, which is why my book is subtitled, Changing Perceptions in a New Constitutional Epoch. We are now in that new epoch.But note that it is not an epoch in which people like YOU make the decisions about the facts for people like US.No, my little dictator, what happens now is that individuals file claims that important facts are being violated, and through a FACTUAL–strictly factual investigation–of what maintenance, in FACT, means in the context of maintenance, law is formulated, sustained or overridden.You do yourself no favor, or honor, by failing to understand the INDIVIDUAL RIGHTS implications of what is going on now.Educate your ignorant self. And grow your police state self up.This goes for your fearless leader, Nouriel, too.