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Wednesday, September 24, 2008

Total US debt rose from 163 % of GDP in 1980 to 346 % in 2007.

Say what?

We are the problem, not the banks, not the government, not the anything else. We have just been borrowing and spending, buying way too much of what we do not need and we have been doing it for twenty eight years.

Forget your credit score. Quit buying so much crap and start saving again.

Take a look at this:
:

..."The aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2000 and 100 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007" (see charts below).



Paulson’s plan was not a true solution to the crisis

By Martin Wolf Financial Times
Published: September 23 2008 19:38 | Last updated: September 23 2008 19:38


Desperate times call for desperate measures. But remember, no less, that decisions taken in haste may shape the financial system for a generation. Speed is essential. But it is no less essential to get any new regime right.

No doubt, the crisis has long passed the stage when governments could leave the private sector to save itself, with just a little help from central banks. For the US, the rescue of Bear Stearns was the moment when that option evaporated. But the events of the past two and a half weeks – the rescues of Fannie Mae and Freddie Mac, the failure of Lehman Brothers, the sale of Merrill Lynch, the rescue of AIG, the flight to safety in the markets and the decisions by Morgan Stanley and Goldman Sachs to become regulated bank holding companies – have made a comprehensive solution inevitable.

The US public expects action. The question is whether it will get the right action. To answer it, we must agree on the challenge the US financial system faces and the criteria for judging how it should be met.

What then is the challenge? The answer given by Hank Paulson, the all-action US Treasury secretary, last Friday, in announcing his “troubled asset relief programme”, is that “the underlying weakness in our financial system today is the illiquid mortgage assets that have lost value as the housing correction has proceeded. These illiquid assets are choking off the flow of credit that is so vitally important to our economy.” The core challenge, then, is viewed as illiquidity, not insolvency. By creating a market for the toxic assets, Mr Paulson hopes to halt the spiral of falling prices and bankruptcies.

I suggest we should take a broader view of events. The aggregate stock of US debt rose from a mere 163 per cent of gross domestic product in 1980 to 346 per cent in 2007. Just two sectors of the economy were responsible for this massive rise in leverage: households, whose indebtedness jumped from 50 per cent of GDP in 1980 to 71 per cent in 2000 and 100 per cent in 2007; and the financial sector, whose indebtedness jumped from just 21 per cent of GDP in 1980 to 83 per cent in 2000 and 116 per cent in 2007 (see charts). The balance sheets of the financial sector exploded, as did the sector’s notional profitability. But leverage, alas, works both ways.

Since US net international debt was 39 per cent of GDP at the end of 2007, virtually all of this debt is an asset of another domestic entity and would net out to zero. But when the gross debt stock is huge and economic conditions difficult, the chances that many entities are bankrupt is high. When people fear mass insolvency, lenders stop lending and the indebted stop spending. The result can be the “debt deflation”, described by the American economist, Irving Fisher, in 1933 and experienced by Japan in the 1990s.

Given the recent explosion in leverage, the challenge is unlikely to be one of mispricing of the toxic mortgage-backed securities alone. Many people and institutions made leveraged bets that have since gone sour. Their debt cannot be repaid. Creditors are responding accordingly.

Now turn to the criteria to be used in judging the intervention. First, it would deal with the systemic threat. Second, it would minimise damage to incentives. Third, it would come at minimum cost and risk to the taxpayer. Not least, it would be consistent with ideas of social justice.

The fundamental problem with the Paulson scheme, as proposed, is then that it is neither a necessary nor an efficient solution. It is not necessary, because the Federal Reserve is able to manage illiquidity through its many lender-of-last resort operations. It is not efficient, because it can only deal with insolvency by buying bad assets at far above their true value, thereby guaranteeing big losses for taxpayers and providing an open-ended bail-out to the most irresponsible investors.

Furthermore, these assets are illiquid precisely because they are so hard to value. The government risks finding its coffers stuffed with huge amounts of overpriced junk even if it tries not to do so. Also objectionable, though more in design than in the fundamentals, were the unchecked powers for the Treasury. Such a fund should be operated professionally, under independent oversight. Finally, if the US government is to bail out incompetent investors it should surely also provide more help to the poor and often ill-informed borrowers.

Yet, above all, a scheme for dealing with the crisis must be able to remedy the looming decapitalisation of the financial system in as targeted a manner as possible. A fascinating debate on how to do this is under way in the economists’ forum on FT.com. To the contributions, including Tuesday’s Comment page article by Dominique Strauss-Kahn, managing director of the International Monetary Fund, I would add one by Luigi Zingales of Chicago University’s graduate school of business.*

The simplest way to recapitalise institutions is by forcing them to raise equity and halt dividends. If that did not work, there could be forced conversions of debt into equity. The attraction of debt-equity swaps is that they would create losses for creditors, which are essential for the long-run health of any financial system.

The advantage of these schemes is that they would require not a penny of public money. Their drawback is that they would be disruptive and highly unpopular: banking institutions would have to be valued, whereupon undercapitalised entities would have to adopt one of the ways to improve their capital positions.

If, as seems plausible, a scheme that imposes such pain on the financial sector would be rejected out of hand, the next best alternative would be injection of preference shares by the government into decapitalised institutions, on the lines proposed by Charles Calomiris of Columbia University. This would be a bail-out, but one that constrained the behaviour of beneficiaries, not least on payment of dividends. That would make it far better than dropping benefits on the unworthy, via mass purchases of overpriced toxic paper.

What then do I conclude? Yes, there may well be a place for intervention in the market for toxic securities. But this is a costly and ineffective way of meeting today’s deepest challenge. What is needed, still more, is a clear and effective way of deleveraging and recapitalising the financial sector, ideally without using taxpayer funds. If such funds are to be used, they must also be injected in as carefully targeted and controlled a way as possible. Comprehensive action is essential, as Mr Paulson has decided. But let the US take the time to make that comprehensive action right.


*Why Paulson is wrong, www.chicagogsb.edu/igm

martin.wolf@ft.com

10 comments:

  1. Does this mean I have to give on the idea of a F-150, made in America, which I don't really need? In the face of rising gas prices?

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  2. I think if congress does not act soon, we will all get down to what we really need.

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  3. The resistance in Congress seems to be growing, as of last report. Some Ohio Congressman said an avalanche of calls to his office was unanimously against a bailout. More or less the same around the nation.

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  4. Taxpayers Will Make Money From Paulson Plan - Larry Kudlow

    According to the Paulson plan, distressed assets will be sold by banks through a reverse auction (the low bid wins) to various investment funds, hedgies, private-equity boys, and other banks.
    And taxpayers will have a strong ownership position in these asset sales.
    ---
    OK, Dull Doug doesn't get the low bid wins deal:
    Why doesn't everyone bid zero, or a negative number?

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  5. Forgive us our debts,
    as we forgive our debtors.

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  6. My negative number is more lesser than your negative number, Doug. The portfolio of shit goes to bob.


    I have to agree with you, I find this new concept both puzzling and exciting.

    Kind of like offering more than the asking price, in reverse, or something.

    ?

    Forgive us out debtors,
    As we forgive our debts.

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  7. Paul said...

    According to Blackhedd at Redstate, Ben Bernacke yesterday gave strong hints that the shaky securities held by Wall Street would be purchased at a price close to the value at maturity.

    in plainer words, there will be no attempt to adjust these securities for the bad judgement of Wall Street or market forces.

    A COMPLETE BAILOUT!

    This looks more and more like a con by Paulsen who by the way was heavily involved in this mess. We really have no way of knowing how bad this financial mess is. The critical information necessary to access how bad this is will never be fully explained. That is the nature of the Federal Reserve. The only indication we have is force with which Paulsen and Bernacke confronted Congress last thursday. We have to trust them, or so we thought. But by bailing our Wall Street completely and painlessly, Paulsen’s and Bernacke’s credibility and judgement all of a sudden doesn’t look so good. This appears to be a sweetheart deal for Paulsen’s friends and his former business partners.

    One of the problems with the whole concept of the Federal Reserve Bank is that the whole financial system depends on the unshakeable faith in the impeccable trustworthiness and judgement of the Federal Reserve Board and it’s chairman.

    Now that Bernacke has fully endorsed this mad money/power grab by Paulsen uncritically, the faith in the Federal Reserve should be and probably will be severely shaken.

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  8. Only someone who considers late night exciting could find that exciting.

    The Stew we're in tho,
    is exciting indeed!
    ---
    We live in interesting times.
    ---
    It goes like this
    The fourth, the fifth
    The minor fall, the major lift
    The baffled king composing Hallelujah
    Hallelujah
    Hallelujah
    Hallelujah
    Hallelujah

    Your faith was strong but you needed proof
    You saw her bathing on the roof
    Her beauty and the moonlight overthrew you
    She tied you
    To a kitchen chair
    She broke your throne, and she cut your hair
    And from your lips she drew the Hallelujah

    Baby I have been here before
    I know this room, I've walked this floor
    I used to live alone before I knew you.
    I've seen your flag on the marble arch
    Love is not a victory march
    It's a cold and it's a broken Hallelujah

    Hallelujah, Hallelujah
    Hallelujah, Hallelujah

    There was a time you let me know
    What's really going on below
    But now you never show it to me, do you?
    And remember when I moved in you
    The holy dove was moving too
    And every breath we drew was Hallelujah

    Hallelujah, Hallelujah
    Hallelujah, Hallelujah

    You say I took the name in vain
    I don't even know the name
    But if I did, well really, what's it to you?
    There's a blaze of light
    In every word
    It doesn't matter which you heard
    The holy or the broken Hallelujah

    Hallelujah, Hallelujah
    Hallelujah, Hallelujah

    I did my best, it wasn't much
    I couldn't feel, so I tried to touch
    I've told the truth, I didn't come to fool you
    And even though
    It all went wrong
    I'll stand before the Lord of Song
    With nothing on my tongue but Hallelujah

    Hallelujah, Hallelujah & etc.

    - Leonard Cohen

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  9. During this same period the DOW increased by 1600%...what's your point?

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  10. Nice Comments.Thanks to all.
    =========================

    john

    Credit Card Debt

    ReplyDelete