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Monday, September 22, 2008


'a year away from the pecora hearings'

that line from josh rosner on charlie rose.

what were the pecora hearings, you ask?

i commented yesterday that, for all the awful precedents being set and constitutional allocations of power circumvented, this is unlikely to put an end to the delevering. doug noland has more.

[T]his gets right to the heart of the matter – where the analytical rubber meets the road. A massive inflation of government obligations; a major government intrusion into all matters financial and economic; and an unprecedented circumvention of free market forces have been unleashed – but to what end? I believe it is a grave predicament that such a rampage of radical policymaking has been unleashed in order to maintain inflated asset markets and to sustain a Bubble Economy. Normally, such desperate measures would be employed only after a crash and in the midst of a major economic downturn – not in efforts specifically to forestall the unwind. Not only will such measures not work, I believe they will only exacerbate today’s already extreme Global Monetary Disorder. They will definitely worsen the inevitable financial and economic dislocation.

I have over the past several years repeatedly taken issue with the revisionist view that had the Fed recapitalized the banking system after the ’29 stock market crash the Great Depression would have been avoided. Some have suggested that $4bn from the Fed back then would have replenished lost banking system capital and stemmed economic collapse. But I believe passionately that this is deeply flawed and dangerous analysis. An injection of a relatively small $4bn would have mattered little. What might have worked – albeit only temporarily – would have been the creation of many tens of billions of new Credit required to arrest asset and debt market deflation and refuel the Bubble Economy. Importantly, however, at that point only continuous and massive Credit injections would have kept the system from commencing its inevitable lurch into a downward financial and economic spiral.

Importantly, market, asset and economic Bubbles are voracious Credit gluttons. I would argue that the system today continues to operate at grossly inflated – Bubble - levels. The upshot of years of Credit excess are grossly distorted asset prices, household incomes, corporate cash flows and spending, government receipts and expenditures, system investment and economy-wide spending and, especially, imports. So to generally stabilize today’s maladjusted system will, as we are now witnessing, require massive government intervention. Enormous government-supported Credit growth will be necessary this year, next year, and the years after that. To be sure, a protracted and historic cycle of Misdirected Credit Runs Unabated.

Today’s efforts to sustain the Bubble Economy create an untenable situation. Washington is now in the process of spending Trillions to bolster a failed financial structure, while focusing support on troubled mortgages, housing, and household spending. Regrettably, this is a classic case of throwing good ‘money’ after bad. Not yet understood by our policymakers, literally Trillions of new Credit will at some point be necessary to finance an epic restructuring of the U.S. economic system. Our economy will have no choice but to adjust to less household spending, major changes in the pattern of spending (i.e. less “upscale” and services), fewer imports, more exports, and less energy consumption. Moreover, our economy must adjust and adapt to being much less dependent on finance and Credit growth – which will require our “output” to be much more product-based as opposed to “services”-based. We’ll be forced to trade goods for goods.

The current direction of Bubble-sustaining policymaking goes the wrong direction in almost all aspects. At some point, the markets will recognize this Bubble Predicament, setting the stage for a very problematic crisis of confidence for the dollar and our federal debt markets.

i've made this point before, as have many others, but it bears constant repetition:

recapitalizing the banks will not support asset prices by itself. the requirement for that would be for the banks to further take that new capital and head off on another incredibly reckless lending binge -- to mimic the conditions of 2003, 2004, 2005 and 2006 whence those inflated asset prices were created. that is not going to happen -- we aren't going back to no-money-down and zero-interest financing, to teaser rates and negative amortization, to liar loans -- and government efforts to make it happen in real terms will be futile.

the primary question for asset managers is whether the government will instead settle for trying to make it happen in nominal terms -- trying to force-feed these many trillions in credit into the economy in an effort to sustain bloated credit supply. and this is whereupon fears of the spectre of a dollar collapse and hyperinflation arise.

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