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Nouriel Roubini's Global EconoMonitor

Insolvent banks should feel market discipline

From the Financial Times:

Joseph Schumpeter famously argued that the essence of capitalism was creative destruction, by which new economic structures are born from the rubble of older ones. The government stress tests on the 19 largest US banks, the results of which are due be announced on Thursday, could have facilitated this process. The opportunity looks likely to be missed.The tests, which measure how viable banks are under adverse economic conditions, have no “failed” category, even if as many as 10 are reported to need additional capital. But, given that the economic environment already reflects the tests’ worst-case scenario and that recent estimates by the International Monetary Fund of financial sector losses have doubled in six months, the stress test results will not be credibly interpreted as a sign of bank health. 

Instead, market participants will conclude that banks requiring extra capital have, in fact, failed. As a result, these institutions will not be able to raise outside capital and will immediately require government help.

Once again, the question will be how the near-insolvent banks can be kept afloat, to avoid systemic risk. But the question we really should be asking is: why keep insolvent banks afloat? We believe there is no convincing answer; we should instead find ways to manage the systemic risk of bank failures.

Schumpeter’s biggest fear was that creative destruction would lead capitalism to collapse from within, because society would not be able to handle the chaos. He was right to be afraid. The response of governments worldwide to the financial crisis has been to give the structure of private profit-taking an ever-growing scaffolding of socialised risk. Trillions of dollars have been thrown at the system, just so that we can avoid the natural process of creative destruction that would take down these institutions’ creditors. Why shouldn’t the creditors bear the losses?

One possible reason is the “Lehman factor” – the bank runs that would occur as a result of a big failure. But we have learnt from the Lehman collapse and know not to leave the sector high and dry when a systemic institution fails. Just being transparent about which banks clearly passed the stress tests would alleviate many of the fears.

Another reason is counterparty risk, the fear of being on the other side of a transaction with a failed bank. But unlike with Lehman, the government can stand behind any counterparty transaction. This will become easier if a new insolvency regime for systemically important financial institutions is passed on a fast-track basis by Congress. Problem nearly solved.

That leaves the creditors – depositors, short- and long-term debt-holders and preferred shareholders. For the large complex banks, about half are depositors. To avoid runs on these deposits, the government has to provide a backstop. But it is not clear it needs to cover other creditors of a bank, as the failures of IndyMac and Washington Mutual attest.

Even if systemic risk were still present, the government should protect the debt (up to some level) only of the solvent banks, not the insolvent ones. That way, the risk of the insolvent institutions would be transferred back from the public to the private sector, from the taxpayer to the creditors.

The government may be able to avoid the mess by persuading long-term creditors to swap their debt for equity, at a loss. The recent failed effort with Chrysler suggests this will not be easy. But a credible threat of bankruptcy could scare creditors into negotiation, to avoid bigger losses.

Suppose the systemic risk problem is solved. The other argument against allowing banks to fail is that after a big loss by creditors, no one would be willing to lend to banks – which would devastate credit markets. However, the creative-destructive, Schumpeterian, nature of capitalism would solve this problem. Once unsecured debtholders of insolvent banks lose, market discipline would return to the whole sector.

This discipline would force the remaining banks to change their behaviour, probably leading to their breaking themselves up. The reform of systemic risk in the financial system would be mostly organic, not requiring the heavy hand of government.

Why did creditors not prevent the banks taking excessive risks before the crisis hit? For the very same reason creditors are getting a free pass now: they expected to be bailed out. For capitalism to move forward, it is time for a little orderly creative destruction.

The authors are professors who contributed to the recently published Restoring Financial Stability: How to Repair a Failed System

71 Responses to “Insolvent banks should feel market discipline”

MarkMay 6th, 2009 at 10:52 pm

Congratulations, it’s been a long time coming, Guest, you deserve all the accolades! :-)Mark

AnonymousMay 6th, 2009 at 6:38 pm

From James Surrowieckihttp://www.newyorker.com/online/blogs/jamessurowiecki/2009/05/misquoting-the-imf.htmlMISQUOTING THE I.M.F.The economists Matthew Richardson and Nouriel Roubini argue today in the Wall Street Journal that, the stress-test results notwithstanding, the U.S. banking system remains “near insolvency,” thanks to the massive losses that the banks still have yet to take on their toxic assets. Given Roubini’s previous writing on this subject, his conclusion comes as no surprise. What is surprising is that Roubini and Richardson cite the I.M.F. as supporting their conclusion. They say the I.M.F. “estimated losses on U.S. loans and securities” to be $2.7 trillion, and that the U.S. banks and broker-dealers accounted for more than half those losses.The use of the $2.7 trillion number is itself dubious, since it’s guaranteed to confuse any unobservant reader. The $2.7 trillion isn’t, as it seems to be, the total projected losses for U.S. banks. Instead, it’s the total losses the I.M.F. projects for assets that originated in the U.S. but are now owned by banks all over the world. That’s an interesting number to know, but it has nothing to do with how much trouble the U.S. banking system is in. (In fact, according to the I.M.F.’s Global Financial Stability Report (pdf), the source of these numbers, banks in Europe and Great Britain appear to be facing far more future pain than American banks.) To know how much trouble the I.M.F. thinks U.S. banks are in, you need to know how much of that $2.7 trillion in losses it thinks U.S. banks will end up being responsible and how much of those losses the U.S. banks have already written off.Roubini and Richardson imply that the I.M.F. believes that U.S. banks and broker-dealers account “for more than half those losses,” which would put their losses at $1.4 trillion or more. But the I.M.F. report projects total losses for U.S. banks through 2010 at $1.06 trillion (see page 34), which is quite a bit smaller, although I guess you could say, “What’s $350 billion between friends?”At the same time, according to the I.M.F., through the end of 2008 almost half those losses ($500 billion) have already been written down by U.S. banks, and they’ve raised almost $400 billion in capital through the end of last year. When you adjust for projected future losses and writedowns, the I.M.F. concludes (as I mentioned yesterday), that U.S. banks need $275 billion in equity capital (all of which could, in theory, be provided by converting the current TARP investment into common stock).That’s still a pretty big number, and it hardly sounds the all-clear siren for the U.S. banking system. But the I.M.F. report simply doesn’t paint a picture of U.S. banks that’s anywhere near as bleak as Richardson and Roubini say it is. Now, their estimates of U.S. losses are considerably higher than the I.M.F.’s, and if they’re right (and certainly Roubini’s track record has been very good), then many U.S. banks will, sooner or later, be insolvent. But it’s deceptive to cite the I.M.F. as supporting that conclusion when, in fact, its report suggests something very different.

GuestMay 7th, 2009 at 7:13 am

When you say the US Banks have raised almost 400 Billion in capital throught the end of last year, is this number including the original bailouts?I think where it becomes confusing to many people is the revision of numbers. I don’t think many people really trust what the banks are saying they have as capital. And of course, why would they when even recent history shows most are not being transparent about their true profits and losses.

GuestMay 6th, 2009 at 7:14 pm

The government’s stress test is a joke. This is why I hate politics. I guess more stupid people will lose their money after this. This article raises a very good point: Why shouldn’t the creditors bear the losses? And we have the usual cycle of experts painting a rosy picture when things look good temporarily and a few months later the usual ‘we-didn’t-see-this-coming’ … no kidding.

Guest fortunately deceased wamu shareholderMay 6th, 2009 at 7:15 pm

It all comes down to this: We need a movement to vote out all the senators and representatives, even if we approve of them. Vote out the incumbents! That’s the only arrow in our quiver. Spread the word: Vote out the incumbents! Nothing else will work. As Dmitri Orlov says, we will then get change that we can suspend disbelief in. Nobody in that congress of pigs is indispensable. Vote ’em out and vote in other incompetents. Then vote those idiots out as well. Write in your dog’s name if necessary. Vote in every election for the sole purpose of firing incumbents. It’s that simple. No other “solution” has a chance of working, and it’s entirely legal.It all comes down to this: We need a movement to vote out all the senators and representatives, even if we approve of them. Vote out the incumbents! That’s the only arrow in our quiver. Spread the word: Vote out the incumbents! Nothing else will work. As Dmitri Orlov says, we will then get change that we can suspend disbelief in. Nobody in that congress of pigs is indispensable. Vote ’em out and vote in other incompetents. Then vote those idiots out as well. Write in your dog’s name if necessary. Vote in every election for the sole purpose of firing incumbents. It’s that simple. No other “solution” has a chance of working, and it’s entirely legal.Hide replies Reply to this comment By Guest on 2009-05-06 16:34:53Your clarion call is worth a double post guest.Definition of a politician: one who seeks re-election…it’s as simple as that.Reply to this comment By Hubbs on 2009-05-06 16:49:33i am on board!That’s the only arrow in our quiver. Spread the word: Vote out the incumbents! Nothing else will work. As Dmitri Orlov says, we will then get change that we can suspend disbelief in. Nobody in that congress of pigs is indispensable. Vote ’em out and vote in other incompetents. Then vote those idiots out as well. Write in your dog’s name if necessary. Vote in every election for the sole purpose of firing incumbents. It’s that simple. No other “solution” has a chance of working, and it’s entirely legalReply to this comment By Guest blindly on 2009-05-06 16:50:34g,ps.i will also email, call, and mail my “representatives” andinform them that they will not get my vote under anycircumstance, no matter what they do between now and such timeas they are voted out as they have participated in the bordello-ization of the primary institution that differentiates afascist regime from a “democratic” representative republic..as long as the other departments of government, justice,investigative and intelligence see no reason to pursue crimescommitted against the people in the name of the people itwould suggest now is a great time for the existing”representatives” to steal as much as humanly possible.being of generous soul i wish them god speed.Reply to this comment By Guest blind bear on 2009-05-06 17:15:35

MarkMay 6th, 2009 at 10:55 pm

Adding my late response to this posting from the previous thread:Unfortunately one problem is that these b*st@rds will turn around and lobby. New politicians = new staff = ripe of the picking (by the wealthy lobbyists) :-(It’s the SYSTEM. The Bolsheviks got rid of all the old politicians, That didn’t turn out well!Mark

Guest tooMay 7th, 2009 at 7:11 am

m,it takes time in the caves of congress tobecome proficient at the deception thatspoils representation, so get them in andget them out.! that is the way the systemis designed to work.

MarkMay 7th, 2009 at 8:18 am

I’d agree (that things could be improved somewhat) IF lobbying were limited.I also think that legislative sessions should be shorter and less frequent.Mark

ChignosMay 7th, 2009 at 11:44 am

I agree that Congress is so bad, vote out the incumbents must be better. However, vote out the incumbents sounds all well and good until you realize that when a new member of Congress shows up in Washington, the first thing s/he must do is go to the entrenched bureaucrats and lobbyists (ever heard of the K street lawyers?) to figure out how things work and what’s really going on. If you send a rookie there every few years what you’ve essentially accomplished is putting more power in the hands of the entrenched and unelected. I seriously doubt it would work itself out in the long run, once the American people caught on. A much better alternative is to cut all these Washingtonians off at the knees by passing Ron Paul’s bill to audit the Federal Reserve. Always vote for the candidate who is most likely to lower taxes (admittedly, sometimes politicians lie about that promise……imagine that!). Insist that the Feds report their spending according to GAAP. A balanced budget amendment would be good. All this is kinda pie in the sky though, given the powers that be. About the only thing practical one can try for is to identify truly responsible ethical leaders (Tom Coburn from Oklahoma also comes to mind) and support them. If you vote for Obama or Bush or McCain you’ve just voted for more self-fleecing. Given the general level of corruption and incompetence, the most likely scenario remains a crash of the USD.

Farnorth5May 7th, 2009 at 2:49 pm

Well yes,the truth is, until you limit the amount of money the Banks/Finance/Insurance people put in to the Election Procedures to a token amount,say $100,000 per Company,at the end of the day the Public Contributions will be outbid by the Wealthy Few.At first glance a three term limit might be helpful at changing the average age of the incumbents,it probably would do nothing for the ABUSE of power.It would continue as the newly elected would probably follow the party line (The thinly disguised Banking policy).They simply would not know the difference, until it was too late in their first term. If they wanted to get reelected,they also would have to follow tye “PARTY LINE”,the status quo….It,s certainly not an easy subject,because you would also have to limit the strengh of the lobby groups with formal legislation as well.There are other countries that have dealt with these issues succesfully(Limited the power-not totally deleted same )

Guest tooMay 6th, 2009 at 7:26 pm

pump and dump.pump and dump.pump and dump.pump and dump.pump and dump.chorus…verse.pump and dump , pump pump and dump.repeat chorus.2nd versepump pump and dump pump pump.repeat chorus..it’s the beat!!

MarkMay 6th, 2009 at 10:59 pm

Yeah, anyone have the feeling that this is all an orchestration to rid the markets of all but the institutionally-controlled investors?The common person, now debt ridden and without any money, won’t be able to play in the big-boys’ markets, leaving only the big boys and their government to conspire to “manage” things that’s “best for the people.”Mark

Guest also , i liked this one!May 6th, 2009 at 7:33 pm

” … when weak earnings and economic news surprise investors … “@ Guest on 2009-05-06 17:26:06 (Roubini)All I can say is that Roubini clearly understands that “investors” (read: the losers) must truly be a very mentally challenged (read: dumb) lot; er, as such, they will obviously / clearly / unquestionably / undoubtedly (etc.) receive that which they are about to deserve.Ho humReply to this comment By PeterJB on 2009-05-06 17:53:27

devils advocateMay 6th, 2009 at 8:32 pm

Dr. Roubini, in times such as these, TPTB prize stability …fear is a strong motivator resulting in fight or flightThose in Power around the World are all together waging war on the publicit’s psychological warfare being waged to create a consumer recoveryout of a phoenix arising: the stock market soaringmass instant amnesia …those with jobs and making $$$$ on the stock marketwill be back to buying cars again — the leading indicatorof “spend now, I want it”2 + 2 does not equal 4 in the world of investing

Guest tooMay 6th, 2009 at 9:52 pm

g,you say “i like pie”. i wonder if you like piethe way, or with the same intensity, that i myselflike pie or perhaps you are stating “i like pie”,not realizing that the kinds of pie are many andthe degree of attraction to “pie”, as you call it,constitutes a wide spectrum?have you tried it with ice cream?

MarkMay 6th, 2009 at 11:02 pm

I think that this requires a certain calculation, in which case might I suggest a mathematical Pi? :-)Mark

weedy seadragonMay 6th, 2009 at 9:40 pm

.@Insolvent banks should feel market disciplineand other funny math..the gross profit from dump (Dgp) – cost of pump (Pc) =dump net profit (Dnp). so…. Dgp-Pc = Dnp …..Dnp = unknown with tremendous potential to coverreckless gambling losses and legal fees andother high/low life type expenses.Pc = all integrity and significant monetary payoutsand payoffs. ( smart investment ).Dgp = the entire economy and lives of people thereinrepresented as a dollar estimate value. anyreally large and random number will do. the bigger the better.the pump and dump unified theory of free rational “markets”… “Insolvent banks should feel market discipline”question: in which alternate universe does the term”discipline” have any meaning? this is exactly thecloth/term that has been rent asunder by theinfluence of the insolvent banks. the banks ate allthe discipline and have left nothing but the bones.. ( like army ants ).the public can eat the bones if we can find them.probably in a closet somewhere, or a basement or vault underground in indonesia. maybe in a cavein costa rica? perhaps trampled on the road?.

FAMCMay 6th, 2009 at 9:59 pm

Dorsch:”The switch-back to “mark-to-make-believe” accounting is an expedient scheme that allows the banking elite to conceal their losses, and use the same obscure and discredited models to inflate their balance sheets. The recent spate of better-than-expected earnings reports by US-banking giants, Goldman Sachs, JP-Morgan, Citigroup, Bank of America, and Wells Fargo is a testament, not to the strengthening of the real economy, but rather due to accounting gimmickry.Barack Obama, elected by appealing to a popular rejection of the Bush administration’s economic policies, has become the new political lackey for the financial aristocracy. His pick for US Treasury chief, Timothy Geithner, is continuing the same policies as his mentors, former Goldman Sachs CEO’s Henry Paulson and Robert Rubin. Step by step, the Fed, the Treasury, Congress, and the White House have allocated an unprecedented $12.9-trillion of taxpayer money and guarantees, to rescue the nation’s top financiers from their own greedy mistakes.US Treasury chief Geithner was a leading architect of the bank bailouts during the financial crisis, while forging close relationships with executives of Wall Street’s giant financial institutions. His actions, as a regulator and bailout king often aligned with the industry’s interests and desires. Wall Street’s share of all company profits in the S&P 500 reached a record 42% in 2006, and with it, greater influence over corrupt politicians in Washington from both political parties.The Wall Street oligarchs are now utilizing trillions in US-taxpayer bailout money and government guarantees, to bolster their balance sheets and generate profits, and speculating in turbulent financial markets. Since March 6th, what’s evolved is a rising US-stock market and inflated bank profits, which in turn, conjures-up hopes that banks will start lending again, to free-up capital for new investment and spending.Many investors are skeptical of the “Green-Shoots” rally, and prefer to call it a “bear-market” suckers’ rally, – one that is destined to fizzle-out and unravel. Yet today’s bargain hunters see a “once-in-a-lifetime” buying opportunity, and are guided by the sagely advice of Sir John Templeton, “Bull-markets are born in pessimism, grow on skepticism, mature on optimism, and die of euphoria.”

GuestMay 7th, 2009 at 10:58 am

The problem is you talk to someone on main street and they haven’t a clue as to what you are talking about. Most people still watch CNN propaganda and believe it wholly. Leave this website and you think the whole world is waking up but talk to people on the streets and Obama is a GOD and they never heard of Geitner.

The AlarmistMay 7th, 2009 at 2:43 am

11th.We only have to pump up the insolvent banks long enough to deprive you of your wealth, and then we won’t need the banks at all.

DougMay 7th, 2009 at 9:30 am

What do you have when the only consumption is survival based? Tell me what is the point of owning everything when it is worthless? How is it that killing the golden geese pays dividends?The consumer is 70% of the US economy. When there is nothing to lose and nothing to gain by being inside the existing system, what happens then?Either TPTB are totally crazy and have totally lost all touch with reality or they have totally lost control of even their own fate.I believe it is both. They are disparate and have lost control because they lost touch with reality. They are so personally greedy. They believe that they deserve to be rulers of the world and should only make profits and gains on their wealth. They have forgotten who it is that produces it and why.Blind faith is dangerous. We are afraid of the blind faith in the Moslem extremists, yet we don’t recognize it when it comes to our own Oligarchs. Our own Oligarchs are causing much more damage to the American way of life than those who attacked us on 911. Yet when I say that I will be accused of blasphemy or worse.When it gets to the point when we don’t need the banks at all, then we have become slaves who have NO freedom and are no longer allowed to the Pursuit of Happiness. Much less be free from the government search of our papers and property without due cause. The greatest experiment in government in the history of man will have come to an end. Let us pray this never happens.

PeterJBMay 7th, 2009 at 4:17 am

For serious consideration, around the World:”Hold on, my friends,to the Constitution andto the Republic for which it stands.Miracles do not clusterand what has happened once in 6,000 years,may not happen again.Hold on to the Constitution,for if the American Constitution should fail,there will be anarchy throughout the world.”– Daniel Webster(1782-1852), US Senator 1851″The American Constitution,one of the few modern politicaldocuments drawn up by menwho were forced by the sternestcircumstances to think outwhat they really had to face,instead of chopping logicin a university classroom.”– George Bernard Shaw (1856-1950) Irish comic dramatist”On the distinctive principles of the Government …of the U. States, the best guides are to be found in …The Declaration of Independence,as the fundamental Act of Union of these States.”– James Madison(1751-1836), Father of the Constitution for the USA, 4th US PresidentSource: in a letter to Thomas Jefferson, 1825It is time to revisit the necessity to step in and take back the governing of our dynamic socio-economic force by replacing the existing corruptive processes and corrupted men with a new process of integrity and a tensile strength that will take the feral 1,000 years to corrode. It only needs a “will”.Keyword: will | integrity | 1,000 yearsHo hum

GuestMay 7th, 2009 at 4:54 am

Can anyone rebut comments stated above From James Surrowiecki article? Eventhough i feel inclined towards roubini but i am not a economist. Thanks in advance

HayesMay 7th, 2009 at 6:44 am

From ECRI – and article on their latest statsMay 2009The End of the Recession (ECRI)The end of this recession — the most severe downturn since World War II — is finally in sight. This is the clear message from Economic Cycle Research Institute’s array of leading indices of the U.S. economy.What are these indicators? One is the ECRI’s U.S. Long Leading Index (USLLI), which has the longest average lead times of any U.S. leading index. Another is the Weekly Leading Index (WLI), which has a shorter lead over the business cycle but is very promptly available.The growth rate of the USLLI turned up in November 2008 and has now advanced for four straight months. The growth rate of the WLI turned up soon after that, in early December 2008, and as of mid-April 2009 it had been rising for more than four months (see the top two lines in the chart below). A rigorous examination of the data affirms that both USLLI growth and WLI growth have been in cyclical upturns for at least four months.Therefore, the economy is on the cusp of a growth rate cycle upturn — i.e., a cyclical acceleration in economic growth. In other words, U.S. economic growth, which, according to ECRI’s U.S. Coincident Index growth rate, is still plunging deeper into negative territory (bottom line in chart), will start becoming less negative in short order.CHART Not Just Green ShootsBut so what? Isn’t this tantamount to the growing conventional wisdom about the slowing descent in economic activity? Indeed it is, but those who dismiss this development don’t understand its implications for a business cycle recovery.In fact, over the last 75 years, growth rate cycle upturns during every recession were followed zero to four months later by the end of the recession itself. No exceptions.Actually, there’s been only one solitary exception in the data we have examined, which go back well over a century. This was the growth rate cycle upturn of 1930-31, which gave way to a renewed downturn. But when this growth rate cycle upturn was beginning at the end of 1930, USLLI growth was turning back down, warning that the firming in growth would soon be reversed, effectively opening the door to depression. That’s not the case today.We know this because the USLLI data go back to 1919, covering not only the Great Depression but also the 1920-21 depression. Another ECRI leading index has a 105-year history, covering not only those depressions but also the panic of 1907 and the associated 1907-08 depression. All of those leading indices, which correctly anticipated recessions and recoveries over long periods of history, are now pointing the same way.While ECRI has known about the growth rate cycle upturn for a while, what’s new this month, beyond the implications of a growth rate cycle upturn, is that the level of the USLLI has been rising for three straight months in a way that signals the end of the recession. The level of the WLI has been rising for six weeks — this wouldn’t yet be significant, except that this comes in the wake of the upturn in the USLLI. Along with the rest of ECRI’s leading indices, these developments are pointing to a business cycle recovery this year, probably by the end of the summer.How Reliable Are These Indices?In order to take this forecast seriously, it’s important to look at the track record of ECRI’s leading indices. Some may recall that these indices helped us predict the 2001 recession. These same leading indices correctly anticipated the current recession, turning down before the recession began. Specifically, the Weekly Leading Index (WLI) turned down in early June 2007. By December 2007, its growth rate had plunged to its worst reading since the 2001 recession.In January 2008, we recognized that “a self-reinforcing downturn has already begun. If allowed to continue, it will amount to the vicious cycle known as a business cycle recession.” At the time, we explained why “prompt stimulus to boost consumer spending can avert a recession. But time is truly of the essence — the stimulus is needed in a matter of weeks, not months.”When our warning went unheeded, I wrote in March 2008 that we had entered a recession that “didn’t have to happen.” Even as stock prices rallied by 12% that spring and upbeat analysts decided that the economy had dodged the recession, we stuck to our guns, knowing that the recession would be recognized belatedly, as usual.In the months that followed our warning, the S&P 500 lost half its value — even today, after a sharp run-up, it’s still a third below its value at the time. But the leading indicators that warned us of recession are now pointing clearly to a business cycle recovery.The Giant Error of PessimismBut isn’t this recession without precedent? Sure, if you consider only the run-of-the-mill postwar recessions to which most economists have fitted their models. But the ECRI’s indicator systems cover not just garden-variety recessions but also jungle-variety depressions, panics and crises spanning well over a century. After all, we’re the only research group in the world that studies business-cycle recessions and recoveries for a living. And we find that this recession shares family resemblances to earlier, prewar downturns that few have systematically examined.Still, most will be skeptical about our forecast of a business cycle upturn. This is precisely what we’d expect. Why is that?Wesley C. Mitchell was a mentor to ECRI’s late founder, Geoffrey H. Moore, whom The Wall Street Journal called “the father of leading indicators.” More than 80 years ago, Mitchell described how the error of optimism at the heart of every boom “grows in scope and magnitude. … But since the prosperity has been built largely upon error, a day of reckoning must come. … Then the past miscalculation becomes patent — patent to creditors as well as to debtors, and the creditors apply pressure for repayment. Thus prosperity ends in a crisis.”Then, as Mitchell quotes A.C. Pigou writing in 1920, “The error of optimism dies in the crisis but in dying it ‘gives birth to an error of pessimism. This new error is born, not an infant, but a giant; for [the] boom has necessarily been a period of strong emotional excitement, and an excited man passes from one form of excitement to another more rapidly than he passes to quiescence.'”The “giant error of pessimism” is now rampant. This is why many will be blind to the light at the end of the tunnel that marks the exit from this recession. But to ECRI’s array of objective leading indices, designed specifically to spot recessions and recoveries, the end of the recession is now in clear sight.(link from ECRI site – full text from the Street .com – copied here so as to avoid all of the garbage on Cramer’s website)

MarkMay 7th, 2009 at 7:03 am

And that new cancer patient never had cancer before in his/her life. Past performances does not guarantee future results…With all that’s riding on managing a slow descent, does anyone really expect any “official” pronouncement to be anything other than one of optimism (read “distraction”)?Sorry, but the fundamentals haven’t changed.Mark

krbMay 7th, 2009 at 12:54 pm

Very good comments Hayes!I’m not an expert and so am curious what types of info go into the calculations you rely on to forecast the impending end to recession.I’ve read research in other places showing that the three major recovering credit markets, all are recovering almost solely from fed support. The lone major credit market that has so far received no fed backing is still deteriorating.I’ve also read research in other places specifically showing where and how TARP money is being funneled into the markets via index etfs and futures in order to keep them propped up, one in a program just renewed for 6 months without comment and effective immediately which is normally not allowed.If credit markets and stock markets factor at all into the calculations you rely on to make your forecasts than your conclusions are just silly. You may be proved correct in that ECRI will soon announce an “end” to the recession. You will broadcast your superior insight, and the fed and treasury will broadcast how effective all of their extraordinary money printing moves have been. But the “end of the recession” will have no more basis in reality than the earnings and asset values companies are now allowed under “mark to market” waiver and GAAP earnings “forebearance”, and the “value” of these companies the markets are now assigning them.What a world we now live in……it turns out that the Enron and Worldcom execs weren’t doing anything wrong after all, they were just ahead of their time. The asset value and earnings creativity they practiced, and for which we sent them to prison, are now the stated policy of our fed, treasury and congress. And we go along because its more palatable to remain blissfully ignorant than to take on the seemingly overwhelming task of reconstructing our financial and governing practices. Respectfully, krb

MarkMay 7th, 2009 at 10:32 pm

.it turns out that the Enron and Worldcom execs weren’t doing anything wrong after all, they were just ahead of their time. The asset value and earnings creativity they practiced, and for which we sent them to prison, are now the stated policy of our fed, treasury and congress. And we go along because its more palatable to remain blissfully ignorant than to take on the seemingly overwhelming task of reconstructing our financial and governing practices.BINGO! Well stated!Mark

MarkMay 7th, 2009 at 6:57 am

Well there you go, there’s no problem after all!Fed’s Bank Results ‘Reassuring,’ Show No Insolvency[Excerpt:]May 7 (Bloomberg) — Federal regulators today unveil what Treasury Secretary Timothy Geithner said will be a “reassuring” picture of a U.S. banking system able to withstand whatever stresses the recession may inflict on it once a handful of institutions add to their capital base.Is it me, or is this the biggest crock of crap you’ve ever heard?If we just wave our hands things will happen magically! Yes, there are things that threaten us, but if miracles happen (read “the Fed/Gov’t stuffs money into our holes), all we need to do is to sprinkle a little of fairy/Fed dust into our books and any potentially bad things go away!Mark

HayesMay 7th, 2009 at 7:29 am

It’s a crock to be sure but the media hype on this and the economy may be having an impact. I was in a Home Depot yesterday (mid afternoon) and it was humming. Where I live more sold signs than for sale signs. Even down in FL before we left a surge in pending sales (albeit at lower prices) in a neighborhood that has been dead for the past year.The ECRI / Shilling interview is worth watching as it captures the two sides of the argument by two highly respected and widely followed individuals.I think Shilling’s comment in the interview that there can be a positive quarter within a recessionary period is probably what we are looking at, not to mention NR’s consistent perspective of a negative ’09 followed by a slow ’10. But imagine the talking heads if that positive quarter comes about – and the market in advance of that will rocket higher.Regardless the 666 on the SPX needs to be tested and then there is the wildcard of PandemicFlu this fall which has been completely disregarded by the market.

GuestMay 7th, 2009 at 8:04 am

Euphoria’s last gasp–the upswing after the popping of the bubble before the bubble starts deflating again. Time will tell.

GuestMay 7th, 2009 at 10:47 am

Right. I see. They need billions more to see themselves through the recession, but they are not insolvent. Assuming that this is remotely believable, I’m thinking that, as usual, the media and politicians have left out a key word: “yet” comes to mind.

RohelioMay 7th, 2009 at 7:29 am

The media play and hostile reader response against E.Warren noted in the previous RGE post is just a preamble. Asking Geithner to explain how ‘bailing out the titans of the financial industry is going to help the taxpayer’ will not harmonize with Obama’s violin. Warren heads the only congressional mandated oversight of Treasury (COP) and we will watch in horror at the slithery tactics employed to undermine her credibility.America has got religion, the sacred song is ‘credit is our only savior’. Don’t mess with anyone’s beliefs.I am beginning to wonder about how the ‘primitive brains’ of the masses will react this time around when they realize that the sweet music is ebbing and there are no more codas. The image of ‘temper tantrum’ or Edvard Munch’s ‘The Scream’ comes to mind. You can bet reasoning and the superior cortex would be overwhelmed by the suffering of such withdrawal. In that state, there is no predicting.Then again, I shouldn’t minimize the creative guile of those clutching the violin. How many Americans realize that the music has been fading for some time now?In a more hopeful note… could a few awaken from these hypnotic refrains and act decisively as those souls in Argentina in the wake of IMF ‘disaster capitalism’? (Humble credit to Naomi Klein/ ‘The Take’)

MarkMay 7th, 2009 at 8:36 am

The setup of the Big Picture emerges. There have been many scapegoats and villains primed to take the heat off the real culprits: “terrorists,” “evil empires,” “anti-patriotic persons,” “gays,” “hippies,” “dissenters” and on and on…The praetorian guard has been groomed by the likes of Limbaugh. When reality starts to show itself TPTB will unleash this lot.It never is the propagandized opponents who are responsible for the tumult.Mark

AnonymousMay 7th, 2009 at 12:44 pm

Don’t forget swine flu. The virus has been traced to a US-owned farm in Mexico, and then back to a 1998 outbreak at the same company in North Carolina. Coincidence? It sure got torture and the idea of accountability for war crimes off the front pages and out of network news . . .

MM CAMay 7th, 2009 at 7:50 am

Green Shoots? where did this term come from…Bernanke) As far as I’m concerned all these “GREEN SHOOTS” are just like a new born baby who shoots green stuff… it’s sticky, icky and stinky and gets thrown away immediatley…. GREEN SHOOTS these days does not equate to JOBS… There are NO JOBS on the horizon…One big of house of cards that did not entirely fall down the first time (Fall 2008). As Roubini says, these corrupt, greedy Banks and financial Companies need to go away once and for all. quite frankly who do they expect to lend to in the future? NO JOBS=NO BORROWING

NedMay 7th, 2009 at 8:09 am

Bank of America is up 2dollars!pre-market tradeing!!I guess all of our dept has just vanished!!!Woopee!! Those green shoots have turned into big rosy flowers. So how come they are bulldozing new homes????

AnonymousMay 7th, 2009 at 8:23 am

Dr.Roubini’s accurate & perceptive analysis of the stress test confirms a basic truth about the political environment of America: Washington DC is a whorehouse and the politicians in it, prostitutes up for sale to the highest bidder. Small wonder Will Rogers use to say: “America has the best politicians that money can buy.” Now is the hour of our discontent. Hopefully, the average American has the guts and fortitude to prove the above to be false about our tomorrow. __JPC__

MM CAMay 7th, 2009 at 8:25 am

NO JOBS means this moving forward:1. U6 of 20-30% for next 5 years minimum2. Published unemployment of 12-18% next 5 years minimum3. if you made 120K in 2007 in whatever job you had that you lost, expect to make no more than 70K in any new job you MIGHT find.3. if you made 100K in 2007 in whatever job you had that you lost, expect to make no more than 60K in any new job you MIGHT find.4. if you made 85K in 2007 in whatever job you had that you lost, expect to make no more than 55K in any new job you MIGHT find.5. if you made 75K in 2007 in whatever job you had that you lost, expect to make no more than 50K in any new job you MIGHT find.6. if you made 60K in 2007 in whatever job you had that you lost, expect to make no more than 40K in any new job you MIGHT find.7. if you made 50K in 2007 in whatever job you had that you lost, expect to make no more than 35K in any new job you MIGHT find.8. if you made 40K in 2007 in whatever job you had that you lost, expect to make no more than 28K in any new job you MIGHT find.So with all this happening, Unions and Union wages and benefits being torn apart (Same with non union and professionals).NO JOBS and LOWER PAYING JOBS= Equal no recovery…confirmation posting kewyword of Insol= Insolvent

GuestMay 7th, 2009 at 10:11 am

Case in point, a recent tale of woe from a woman who works out at my gym. She had some kind of marketing job and was used to making over $150k. She is in her 50’s and has been out of work over a year. She is not employable in her former field at just about any rate of pay. She knows it and is thinking of retooling by going to nursing school, except she has no money to do this because she has no savings anymore, a big mortgage, and a car payment. That is what you call being between a rock and a hard place. Her only source of possible funds is the ever decreasing equity in her home, which she knows she should sell, but does not want to because she feels she would be “giving it away” in this market. Never mind that the skyrocketing gains of the last few years were a mirage.

FEDupMay 7th, 2009 at 8:54 am

Let the rally continue: stocks continue their rally ignoring millions of foreclosures, millions of job losses, millions on food stamps and Medicaid and TRILLIONS of NEW DEBT. Forget about PE ratios present or future earnings; it’s all irrelevant! We must also ignore the bankruptcy of GM and Chrysler, malls across America including millions of small businesses shortly to be followed by commercial real estate foreclosures and freezing of pension fund contributions by companies. Wall street and our Government tell us everything is fine and getting better all the time so go out and keep on spending. If Americans learn only 2 things from this debacle, it is: constantly e-mail and threaten to vote out the corrupt leaders at all levels of govt and DO NOT DO ANY BUSINESS WITH THE CORPORATE ELITES (BofA, Citi, AIG, etc).

GuestMay 7th, 2009 at 9:05 am

We are now entering the faith based economic period. We built up huge debt with “ponzi prosperity”(Das), and we are now “going through the looking glass” to a “socially engineered” bargain mania that will causethe present losers to double down and lose again. You can only run the world economy in this fashion, if youare entities that have all the economic, military, food and health pandemic tools at your disposal. This is a chess game amongst few international players. They are maintaining their derivative casino active which guarantees payouts by exemption from bankruptcy stays. One of those manipulations will go terribly wrong and pestilence and famine may result in chaos.There has to be a separation between geopolitical nation-state decisions and economic social engineering. This diffuse and decentralized financial power elite have only one short term plan. Maximize profits at any cost! You cannot run a planet like this!

HayesMay 7th, 2009 at 9:13 am

We are now entering the faith based economic period. We built up huge debt with “ponzi prosperity”(Das), and we are now “going through the looking glass” to a “socially engineered” bargain mania that will cause the present losers to double down and lose again.___________perfect descriptions “faith based economics”, “socially engineered bargain mania” and “present losers to double down”You must have lifted these from Axelrod’s playbook

HayesMay 7th, 2009 at 9:16 am

latest from RitholtzGM: Out of the Dowhttp://www.ritholtz.com/blog/2009/05/gm-out-of-the-dow/if true cisco will get a nice bump

HayesMay 7th, 2009 at 9:24 am

further to the lead article above I guess Turbo and Ben disagree with the Professor:Fed’s Bank Results ‘Reassuring,’ Show No Insolvencyhttp://www.bloomberg.com/apps/news?pid=20601087&sid=aPhYF1i287sc&refer=home

GuestMay 7th, 2009 at 9:53 am

Is the disagreement based on something readily identifiable? (i.e. considering vs. ignoring off balance sheet assets)

HubbsMay 7th, 2009 at 11:21 am

Stress Test exists only as a vehicle to feed the public false reassurance. The objectives were not to evaluate the financial health or survivability of banks.To accomplish this,Feds needed to:1.) Have time to adjust the findings.2.) Pick on one or two banks, but not deliver a fatal blow, to make it look like it wasn’t a blanket free pass for everyone.3.)Make sure that the key players were unscathed at all costs. (the operative word is cost!)

Pecos BankerMay 7th, 2009 at 10:16 am

Does there have to be a conspiracy in order for their to be a conspiracy? Let me introduce the term “subjunctive conspiracy”. Since we will never know if there actually is a conspiracy to take every last penny from the poor and give it to the rich, we can make do with the following artifice: “If there *were* a conspiracy, here’s how it would play out…” With this construction, one can reconstruct the entire scenario from A to Z without claiming that there actually is a conspiracy, even if, by Occam’s razor, that provides the the most simple and cogent explanation. With peak oil, being past the point of no return on global warming, economic collapse, probable world-wide war, etc. wouldn’t it make sense for the PTB (another construct not to be taken at face value) to reach for every last penny? It is part of the current Kulturgeist that the film, “The Titanic” was so prophetic.

FEDupMay 7th, 2009 at 10:29 am

agree: one simply looks at the end results. All of these actions were undertaken by the corporate elites who were simply operating within governmental policies and without fear of consequences. But what is necessary to wake up the masses is a much more difficult question: is it more pain and suffering?

econoprophetMay 7th, 2009 at 10:55 am

Pecos Banker,You know, that’s funny – I was having this same thought last night. I had no idea that it had a name (“subjunctive conspiracy”), but I was going over in my mind how there’s no possible way for me to know any of the facts that are outside of my own little personal space.As an intellectual exercise, I think the idea is interesting. You have to admint, however, that the creative nature of the human mind allows for an infinite number of A-Z’s, even if the initial construction we all begin with is exactly the same…

MarkMay 7th, 2009 at 10:51 pm

I believe that TPTB knew everything that was going to come this way. The problem is, that any attempts to change course would fail because:1) If announced only by a handful they would be targeted (by those that wouldn’t sign up from continuing to run everything over the cliff);2) An announcement by ALL would be viewed along the lines of a push toward One World Government- lots of backlash (esp by groups looking to control the world themselves [many religious groups/organizations]).I’d asked this before, but it bears repeating: if TPTB horde all the money, what good will money do for them when the masses, upon which TPTB rely on (skimming money off of transactions), aren’t in the game? It comes down to the analogy of the two millionaires alone on an island: what use are those millions then?Regardless of intent, the growth-programmed world is going to meet up with the finite planet. No rearrangement of the deck chairs is going to make a difference.Mark

GuestMay 7th, 2009 at 11:49 am

The NR post and commentary from all of you above bloggers is fabulous! The truth is shouted, if only from this modest pulpit and in a few nooks and crannies. Keep up the good work!!

econoprophetMay 7th, 2009 at 12:40 pm

If you have any doubt as to whether or not this administration’s plans to revitalize the economy will work or not, there is only one sentence from Timothy Geithner’s article in today’s New York Times that you need to read:”This is just a beginning, however. Our work is far from over. The cost of credit remains exceptionally high, and businesses and families across the country are still finding it too hard to borrow to meet their needs.”The purpose of this administrations actions is to create a system that will further indebt its citizens. This cannot, will not, and never has worked. It may prop up the Tower of Pisa, but everybody knows it will fall someday.Any individual, family, community, or country that must borrow to meet its “needs” is in trouble. As Mark likes to say, it’s just not sustainable. The foundation of a healthy economy is the ability to meet one’s needs without taking on debt. Indeed, if one has to take out loans to meet one’s needs, one is, by definition, a slave! So in effect, Mr. Geithner is telling me that he’s doing his best to heal my master so that I can place myself back into his service. Well, thank you Mr. Geithner, but I think I’ll take a pass – and I hope that there are many more like me who will do the same.Damocles’ sword dangles above our head. This administration wishes to tie us to the ground, so that we can’t avoid our fate. The vast majority of the world’s citizens seem to think that they have no choice – so they bring the rope for their own hanging. I, for one, refuse the demands of my “leaders”. No more debt, no more doing business with the oligarchs, no more blind fealty to self-serving leaders. There are things I can’t avoid due to my duties as a citizen, but in all other respects, I’m taking my life back, one step at a time. Husband first, father second, disciple third, citizen fourth – the rest is just the details.

TfTMay 7th, 2009 at 12:51 pm

From Henry CK Liu’s The Burden of Elitism(emphasis mine)

Theories behind monetary economics harbor an ideological bias toward preserving the health of the financial sector as a priority for maintaining the health of the real economy. It is a strictly elitist trickling-down approach. Take good care of the moneyed rich with government help and the working poor can take care of themselves by market forces in a market economy. All are expected to swim or sink in a sea of caveat emptor risk, but bankers can swim with government-issued life jackets filled with taxpayer money on account of a rather peculiar myth that without irresponsible bankers, there can be no functioning economy. The fact is: while banks are indispensable for a working economy, badly-run bank ignoring sound banking principles are not. What is needed in a depression is not more central bank money for distressed banks suffering losses on loans from collapsed assets prices, but government deficit money to sustain full employment with living wages.In popular parlance, the Fed is the government-paid doctor of Wall Street, through taking care of the banking system it regulates, with unlimited state power to create money backed by the full credit of the United States, a nation founded as a democratic republic in which sovereign wealth is supposed to belong to the people, not the banks. Yet the Fed is not the doctor of Main Street where the nation’s wealth is created through full employment and living wages. Instead, under market capitalism, the fate of Main Street is left to the manipulated workings of market forces shaped by central bank money freely available to the financial elite beyond the understanding, control and even awareness of most retail market participants. Thus market forces are manipulated to favor those institutions deemed too big to fail, and at the expense of the general public who are hapless participants in a manipulated financial market.Central bankers are savvy enough to know that while they can create money, they cannot create wealth. To bind money to wealth, central bankers must fight inflation as if it were a financial plague. But the first law of growth economics states that to create wealth through growth, some inflation must be tolerated. The solution then is to make the working poor pay for the pain of inflation by giving the rich a bigger share of the monetized wealth created via inflation, so that the loss of purchasing power from inflation is mostly borne by the low- wage working poor, and not by the owners of capital the monetary value of which is protected from inflation…. …

London BankerMay 7th, 2009 at 12:54 pm

Hey there! I read Professor Roubini’s piece in the FT this morning and felt how much I missed this blog. Then I kept on working until I’d put in my 12 hours . . . I don’t know what I was thinking taking a day job after all these years, but I’ve got a great team working for me, and we’re making good progress, so I guess I’ll stick with it.In this corner of the world we are finally getting a bit quieter, with more pauses in conversations, easier reservations in restaurants, and falling property prices as a concern for many and a hope for some. We are going to skate through unaffected as many here hoped, but I’m still reasonably optimistic that we do okay.Just as many on this blog knew in spring 2007 that the markets were being rigged and the froth was orchestrated, I get the same sense today. TPTB are engineering something, and only they know the timings they will choose for the next big thing. War? Crash? Failure? Coup? Who knows?

YveMay 7th, 2009 at 4:34 pm

Darn, I thought for a minute there may be an oasis somewhere! Keep up the good work (whatever your mystery job is) London Banker. Good to see your post after so long. I used to regularly look for your comments. So have you figured out a way to save the world yet? Again, just me being hopeful ;).

guestMay 7th, 2009 at 6:07 pm

They constanly make fun of Roubini in NBC mad money show i can not believe how obsessed they are. Any given chance they like to critisize him , they dont miss it.Crammer thinks economy is doing perfect and banks are doing even better.Nbc become a governement channel as the ones they used to have in third world countries. This is so interesting to watch i dont know how those people can sleep at nights after all those lies they are puking right and left.

GuestMay 7th, 2009 at 6:29 pm

who do you think owns these networks? once you figure that out, then you’ll know why they keep puking the lies, misinformation, and distractions.