Bernanke Is Fighting the Last War

Wall Street Journal ^ | OCTOBER 18, 2008 | BRIAN M. CARNEY

[vietvet67]

On Aug. 9, 2007, central banks around the world first intervened to stanch what has become a massive credit crunch.

Since then, the Federal Reserve and the Treasury have taken a series of increasingly drastic emergency actions to get lending flowing again. The central bank has lent out hundreds of billions of dollars, accepted collateral that in the past it would never have touched, and opened direct lending to institutions that have never had that privilege. The Treasury has deployed billions more. And yet, "Nothing," Anna Schwartz says, "seems to have quieted the fears of either the investors in the securities markets or the lenders and would-be borrowers in the credit market."

The credit markets remain frozen, the stock market continues to get hammered, and deep recession now seems a certainty -- if not a reality already.

Most people now living have never seen a credit crunch like the one we are currently enduring. Ms. Schwartz, 92 years old, is one of the exceptions. She's not only old enough to remember the period from 1929 to 1933, she may know more about monetary history and banking than anyone alive. She co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression.

Since 1941, Ms. Schwartz has reported for work at the National Bureau of Economic Research in New York, where we met Thursday morning for an interview. She is currently using a wheelchair after a recent fall and laments her "many infirmities," but those are all physical; her mind is as sharp as ever. She speaks with passion and just a hint of resignation about the current financial situation.

[JasonC]

We are not bankrupt, that is nonsense. A few banks that did not have sufficient equity to handle $1.4 trillion in loan losses required government help to the tune of less than 2% of our net assets.

We don't get to make these things up. The Fed tracks every dollar spent through the banking system. It keeps balance sheets and income statements for every sector of the US economy, households, corporations, small businesses, and government. We know exactly what the net asset position of each sector is. US household sector debt is one *fifth* of their net assets. Both business sectors, which are smaller, have debts of only half of their assets.

Debts are owned, you know. They are claims against real assets, the real assets are the underlying values. All of them owned. Where the equity owner doesn't own something, his creditor does, but nothing strides the earth un-owned. Our net *foreign* debts, meanwhile, are less than 5% of our assets.

What kind of ignorance can cause this level of idiocy? Who do you imagine owns every office building and shopping mall and small business you drive past every day, if not Americans? What can you possibly imagine debt is, that you could think any of it would be worth zero or less depending on how it is financed? Who do you think owns all the debts? Do you think there are borrowers without lenders striding around, having borrowed from a non-existent pit in the middle of the sky, or something?

[marshmallow]

Um, why do you think the government just added $250 billion to bank equity and started its offer to buy $450 billion in assets from them? Addled brains looking for any stick to bash responsible authorities. Just spewing nonsense.

Nothing has changed regarding the flow of credit. The $250 billion did nothing, nor will it.

Here's an example of why.

A major part of the problem is that banks want government blessing to value their assets any way they want, using whatever numbers they desire. On Oct. 13, the American Bankers Association sent a letter to SEC Chairman Christopher Cox, demanding that the commission override the U.S. Financial Accounting Standards Board's latest guidance on fair-value accounting. Four days earlier, in a letter to the FASB, the ABA had agreed that companies should include liquidity risk when determining the fair value of an asset for which there's no active market. Then for some reason -- maybe it dawned on them how much this would hurt banks' earnings -- the bankers changed positions. In its latest letter, the ABA said including liquidity risk in fair-value measurements is bad, because it ``brings the guidance full circle back to distressed sale values.''

On Oct. 14, the SEC's chief accountant, Conrad Hewitt, kneecapped the big auditing firms, which had taken a unified stand on when to require write downs of so-called perpetual preferred securities. Hewitt, in a letter to the FASB, sided with the ABA, saying such holdings could be treated as debt when checking if write downs are needed, even though the securities are treated as equity on the balance sheet. That lets companies stretch the meaning of temporary further into the future, and postpone losses, as long as the credit of the outfits that sold the securities hasn't deteriorated.

While these sort of games are being played nobody can really be sure of the value of any assets, what price to pay or the figures on balance sheets and credit markets will remain frozen.

Count on it.

[JasonC]

Since the level of ignorance on display here is staggering, the first duty of a rational man is to recite the mere facts. Here is the balance sheet of the entire US household sector as the end of the 2nd quarter of 2008, the latest for which full data is available.

Total Assets - $70.488 trillion
Total Liabilities - $14.495 trillion
Net Worth - $55.993 trillion

Details of assets -

tangible assets - $26.149 trillion

of which

real estate - $21.781 trillion
consumer durables - $4.114 trillion (mostly cars)
equipment of non-profits - $0.254 trillion

financial assets - $44.340 trillion

of which

savings deposits and CDs - $5.910 trillion
money market funds - $1.411 trillion
currency and checking - $71 billion
foreign bank accounts - $69 billion
corporate bonds - $1.858 trillion
municipal bonds - $0.912 trillion
agency bonds - $0.767 trillion
treasury bonds - $0.304 trillion
(2/3rds of those savings bonds)
mortgages owned directly - $154 billion
commercial paper owned directly - $128 billion
other loans - $17 billion
stocks owned directly - $4.867 trillion
mutual fund shares - $4.860 trillion
life insurance reserves - $1.203 trillion
pension funds - $12.264 trillion
small business & professional equity - $7.845 trillion
loans on securities (owned) - $0.967 trillion
miscellaneous assets - $737 billion

That's right Virginia, the rounding error catch-all for stuff that doesn't fit in the main categories is as big as the entire bailout funding bill - much of which will be paid back.

Details of liabilities, which remember are $14.5 trillion for the household sector -

home mortgages - $10.640 trillion
commercial mortgages - $267 billion
Notice, less than *half* the real estate line, combined
consumer credit - $2.565 trillion
liabilities of non-profits - $261 billion
bank loans - $112 billion
other loans - $130 billion
security credit (used) - $290 billion
trade payables of non profits - $205 billion
unpaid life insurance premiums owned - $25 billion

as for the income statement, personal disposable income at the same time, which means after taxes, is running at a $10.822 trillion annual rate. Net worth is over 5 times that personal disposable income.

Can the hysterics, stop listening to mere MSM doom-mongering spin, and wake up. America is the wealthiest society in world history and we are going to be wealthy tomorrow. Socialists want you to think otherwise, tehy want you to think that capitalism is somehow all just a scam, but they are flat-out lying.

[JasonC]

Nonsense, CDS spreads instantly fell by more than half, default risk for all financial debts plummeted, firms that faced 30% rates in the secondary market now see 12% rates, and those facing 12% rates see 9-10 instead. Libor dropped when it has been spiking. The infusion of capital to the banks prevented the collapse of Royal Bank of Scotland and Morgan Stanley, which between them would have been a default twice the size of the Lehman, AIG, and Wa Mu failures, and brought all remaining large banks out of the critical wards. Moreover, the shorts betting they would all die were decimated, especially by the CDS reversal, and dumped tons of their other holdings as a result. That contributed to the drop in oil to $70, and also marked the stock market lows as others bought on their distress.

It is working fine. Will it prevent a real economy recession? No, that was baked in a year ago. But it has already prevented a systemic collapse and it will continue to do so. The worst is behind for the financial system. The financial system will survive the recession, and we will conduct all future adjustments necessary within that recession, with a functioning banking system.

[marshmallow]

Here is the balance sheet of the entire US household sector as the end of the 2nd quarter of 2008, the latest for which full data is available.

Indulge a miserable, mentally challenged dunce for a moment here, O Great Intellectual Colussus.

The 2nd quarter of 2008??

Isn't that before the...uh..........you know....."bubble" burst? Ergo, the $21 trillion real estate figure, for example, is now likely to be shaved by a rather large percentage, no? And may fall even further?

Not to speak of the other numbers.

Are you telling us that the picture painted by those figures is current?

[Toddsterpatriot]

You're trying to convince him with facts. That won't work. He thinks Social Security and Medicare obligations are debt.

[berdie]

Well, I will certainly read the text you suggested.

I will keep in mind, however, it is evidently published by the Feds (who I have implicit trust in /s) and the ability to spin the story.

I take exception to assumption that I am repeating media spin. (Sounds to me like you might be though.)

I am a student of common sense. If all your assets are heavily mortgaged and your unsecured debt exceeds your income, as is the case in the present crises, a slight shift of the wind can cause the house of cards to fall. I don't think you can deny this, given the economy of our country and a large number of the citizens within.

I understand this pretty well.

When you complete a course in Common Sense 101, we'll talk.

[JasonC]

Real estate prices peaked in the first quarter of 2006, not the 2nd quarter of 2008. Did the real estate equity line therefore plummet over that stretch? No it did not. At the end of 2006, the real estate equity line item was $21.822 trillion, and as of the end of 2Q 2008, is was $21.781 trillion. Down all of $41 billion or 0.2%.

"Huh? How is that possible? I thought house prices dropped 20% nationwide". Do you think no new houses were made in the interval? Do you think shopping malls and office buildings just stopped being put up? We invest *a trillion a year* in real estate in this country. The declines in the value of the previously existing structures in the worst real estate collapse in living memory, was matched dollar for dollar by the new value of new buildings put up in the same period. Americans *work*, goddamn it! That is *why* we are rich!

Personally I've seen some net savings chomped up in my 401k, but I've got about as much in it now as when the bear market started. I'm shoveling it in as fast as the values drop. When prices recover so will I. Same thing happens on a national scale.

There is no way a people earning $10.8 trillion a year go bankrupt because of a one-off $1.4 trillion *world wide* in bad debts. The narrow capital of a dozen banks are not enough to take all of that hit, and that is causing the current crisis. But all of us, combined? Jesu Christo folks, buy a clue! We make that new every 40 days.

[JasonC]

Recording every dollar's movement through the banking system since 1945, and published detailed tables for every sector of the economy every quarter like a swiss watch for over six decades, is *not* *spin*. It is *measurement*, *fact*, *reality*.

[palmer]

The Z1 is always delayed, so the third quarter 2008 won't be out for a month or so. What JC is not telling you is that the same report shows the total nonfinancial debt to be 51T (includes households, corps and govt). The GDP of the U.S. is the only source of payments for that debt and is made up of exports, consumption, government investment (e.g. infrastructure) and private investment.

Consider what would happen if interest rates were 5% (instead of the artificial 1% Fed target). We would need 15% of GDP to pay the interest on the debt. That's 15% of the revenue of our not-very-profitable service economy and a 15% haircut from every public and private investment. That's clearly unsustainable. So instead the Fed jacks down short term rates so the debt can be rolled in all sorts of crazy financial vehicles instead of paying interest.

We can get away with this as long as the U.S. keeps an overall healthy credit rating and net foreign investment. Based on past performance we are ok for now, T-Bills and the dollar are still in strong demand especially from Europe which is in worse shape financially than we are. But that's just a temporary condition, the level of debt is unsustainable and will have to be reduced through default and monetary inflation.

[berdie]

These tables are recording the past.

Not the present or the future.

[palmer]

one-off $1.4 trillion *world wide* in bad debts.

The 1.4T is a lowball for nonfinancial debt and will grow as the real estate market continues to slump through next year. The real losses are in financial obligations which, for the most part, are undeclared and unacknowledged. That's the main reason why the credit markets are frozen and will stay that way. Let us know when Iceland reopens for business, then we know things have thawed.

[Travis McGee]

Anna agrees with Ludwig.

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

-~~Ludwig Von Mises

[Travis McGee]

Geez o flip, isn't there a single economically literate conservative left in the world?

Your patronizing ignorance is monumental.

"I'd like to see mainstreet try to live for 6 months without financiers directing their activities. They be reduced to shooting each other over the last can of campbells."

5 posted on Saturday, October 04, 2008 3:38:33 PM by JasonC

[JasonC]

Wrong, debts in intermediation are assets to the owner and just pass earnings along. If A lends to B lends to C lends to D lends to E, there is 5 times the gross debt as net debt in existence. But the same payments from E or the assets owned by E, pay all of them. The household sector owns all the assets and only has $14 trillion in debts. All the debts of the other actors are owned by the household sector, directly or through intermediaries.

[JasonC]

The US economy is the greatest engine of wealth creation in the history of the world, it made that $56 trillion in net worth, and it makes vastly higher net worth every decade. And it will continue to do so. There is nothing fundamentally wrong with any of it, and nothing to stop it from doing so.

Doom-mongering communists have convinced even pretend conservatives and pretend supporters of capitalism that capitalism is some doomed scam that must end in chaos and revolution, 3 weeks before a communist wants to be elected president of the United States. But it is all a pack of lies from start to finish, and it is absurd that you have all fallen for it.

Wake the heck up, turn off the doom-mongering TV, walk around outside and look at the actual wealth of the country. Get on a plane and take the window seat, and look around. It was all a howling wilderness not long ago, and we made it what you can see, without the benefit of your nonsense ideologies and despite every recession and financial crisis along the way, one a decade. And we will again, as always.

[palmer]

The household sector owns all the assets and only has $14 trillion in debts. All the debts of the other actors are owned by the household sector, directly or through intermediaries.

Those intermediaries do really owe the other 37 trillion (51-14). If in fact you are arguing that the other 37 trillion is owed to each other and to households so it is a wash, that is only partly true. Some 7.7T is owed to the rest of the world.

Also as we can see from the current crisis, even writing down a paltry portion of the debt causes financial chaos. If we wrote down even 10% of the 30T domestic wash debt that you say doesn't matter, the financial markets would cease to exist, not to mention the fact that you can't extract it from the foreign debt and the dollar would crash.

The bottom line is we have to make payments on 51T of debt from a GDP of 14T.

[palmer]

Doom-mongering communists have convinced even pretend conservatives and pretend supporters of capitalism that capitalism is some doomed scam that must end in chaos and revolution, 3 weeks before a communist wants to be elected president of the United States

I find it ironic that Obama has retained the support of Volker, the only recent strong money Fed chairman, who, appointed by Carter, set the stage for the Reagan boom (along with Reagan's policies). Perhaps the same thing will happen again after one term of Obama.

[marshmallow]

Nonsense, CDS spreads instantly fell by more than half, default risk for all financial debts plummeted, firms that faced 30% rates in the secondary market now see 12% rates, and those facing 12% rates see 9-10 instead. Libor dropped when it has been spiking. The infusion of capital to the banks prevented the collapse of Royal Bank of Scotland and Morgan Stanley, which between them would have been a default twice the size of the Lehman, AIG, and Wa Mu failures, and brought all remaining large banks out of the critical wards. Moreover, the shorts betting they would all die were decimated, especially by the CDS reversal, and dumped tons of their other holdings as a result. That contributed to the drop in oil to $70, and also marked the stock market lows as others bought on their distress. It is working fine.

It's working fine?

A check for one month's supply of the beverage of your choice on its way to you if you can provide a link to any economist, financial commentator or anyone of any gravitas who currently subscribes to such a far-reaching and optimistic analysis of the effects of the $250 billion capital infusion.

I thought the purpose of the capital infusion was to free up the credit markets? How exactly did it prevent the collapse of Morgan Stanley? It was Mitsubishi that pulled their ass out of the fire with the deal which involved $9 billion cash for a 21% stake. Where does Paulson's capital injection fit into that picture?

As for the Royal Bank of Scotland in the UK, it was effectively nationalized when the British government bought a 60% stake.

Paulson's $250 billion is still in limbo.

[berdie]

Although I certainly appreciate your passion on this subject, I am somewhat offended that you assume to know my ideology. Or that I fail to see the greatness of this country. Or that I am swayed by television or any other medium. I find that to be somewhat presumptuous on your part.

I guess my “nonsense ideology” of debt being the instrument of economic failure is our basic disagreement. Be it a country, state, city or individual..too much debt will destroy. This has nothing to do with capitalism, imo. You have stated that the private sector owns X number of properties (paraphrasing). The private sector is mortgaged to the hilt and in reality does not “own” properties. Our country is mortgaged to the hilt. The “pay as you go” philosophy vanished 50 years ago.

If I read your post correctly, you feel the current economic crisis is contrived for the election. We may agree somewhat on that point. It certainly appeared at a convenient time. But...if we, as a country and as individuals were not so heavily in debt, it would have been a blip on the radar. It would not have set up the circumstance we now face.

Of course we, as a country, will survive. This financial crisis is unique in the fact we are so tied to global finance. That is pretty unsettling. And the fact that people caught in the financial melee could be willing to vote for someone promising relief, regardless of his beliefs is even more unsettling.