The break-up of Lehman Brothers, the fire sale of Merrill-Lynch, and the woes of AIG are, sadly, not fundamentally symptoms of corporate malfeasance, or the sad lot of an unlucky few, but, rather, signs of a worsening storm. The storm has several fronts:
1. Inflation - rising commodity prices slowly spreading to wages and consumer goods will suppress long-run growth prospects, decrease investment and increase long-term interest rates.
2. Over-levered consumers - low savings rates, cheap credit (cards and mortgages) and a culture of profligacy has run its course. The US consumer has no more money to spend; their houses are underwater and their bank accounts are empty. All that's left are mounds of debt than will take years to pay back.
3. Over-levered companies - cheap debt used to finance LBOs and other acquisitions has left corporate America struggling to generate enough cash to operate in a declining economy while still servicing its debt.
4. Under-financed municipalities - local and state governments face sharply declining revenues from declining property taxes and years of mismanagement.
5. Wasteful federal government - deficit spending for the foreseeable future may continue to drive down the dollar and drive up long-term interest rates, while making additional fiscal stimulus risky.
6. Slowing growth overseas - Europe, the UK in particular, is suffering economically as well. China and India have to deal with issues of inflation, internal instability and other growing pains which may limit their ability to support the US in attempting to export its way out of its economic mire.
Am I being overly gloomy? Perhaps. Smart government policy could go a long ways to help things. For example, offering more H1Bs to skilled overseas workers who are willing to work in the US and invest in US real estate could help stabilize the housing market. Reducing spending on Iraq and using the funds to rebuild America's crumbling infrastructure could help create jobs and stir growth. Cut taxes on small businesses and start-ups.
All should be done. But, alas, too little, too late. I am not going to be the one to put lipstick on this pig. Batten down the hatches. We are in for the storm of a lifetime.
.jpg?t=20120527181101)
Article comments
— go to most recent comments1 - cuervodeluna
Yep, you ARE in for the storm of a lifetime.
But, all in all, I have to say that nobody deserves that storm more than the peppy people of Gringolandia.
As the Good Ship Lollipop is flushed into the abyss of history, remember that a little bird warned you about all this quite some time ago.
And it was not Chicken Little.
2 - Nick First
Nothing wrong with a little schadenfreude, but the real danger is the contagion spreads to the rest of the world. This is looking increasingly likely.
3 - Lisa Solod Warren
If only it was just the greedy bloodsuckers who would suffer the consequences, but that is never the way, is it?
Whatever happened to real Crime and Punishment????
4 - Nick First
I believe a cynical man once said, "American capitalism is unique because we privatize the profits and socialize the losses."
5 - Matthew T. Sussman
This story does fit into the political spectrum. And that's the problem.
6 - Nick First
Yes, this is the problem in the US. We have partisan politics, but we have bipartisan disasters.
7 - Baronius
Matt - What do you mean?
8 - Baronius
cuervodeluna, weren't you banned from this site for personal attacks?
9 - bliffle
I've been bringing up the "privatize the profits and socialize the risks" mantra of modern US business for a long time. I've watched it developing for 30 years.
At this point I think we have to admit that our attempts at "privatizing" various activities is a total flop. Whether it's Municipal Water Departments, the Blackwater oafs in Iraq, or health care, they've all failed. All they did was increase costs and restrict supply!
10 - bliffle
Contrast the bankruptcy situation of the officers of AIG with that of the poor guy who goes broke because of their machinations.
The exec takes his golden parachute and retires to his luxurious digs. No problem.
The victim of his crimes finds it almost impossible to qualify for bankruptcy help because of the strict new rules.
11 - Nick First
But in times like these, I think we have to be careful not to throw the baby out with the bathwater. Private markets are often much more effective than government for providing many goods and services. The trouble is, many markets need some form of helpful regulation to ensure well-functioning markets. The current situation has arisen from decades of poor regulation. So going forward, hopefully we will have better regulation, but that need not necessarily be more regulation.
12 - Mooja
There is no better regulation than a good, large failure every now and then. I can assure there are real shock waves propagating throughout the financial industry. Increased government regulation is a costly, bureaucratic whack-a-mole game. When will we shed this notion that the government must be every citizens financial nanny? Failure is not a dirty word. It is natural and it this too shall pass.
13 - Dave Nalle
Bliffle, could you explain to me how AIG makes people go bankrupt? I'm not clear on how that works, exactly. Is it just the loss on stock investments or something more nefarious?
Dave
14 - Nick First
It's true occasional failures can improve market function by making other firms re-evaluate their risk exposure. However, so many of these financial companies are "too big to fail," which means tax payers are subsidizing their risk taking, and they therefore need to be regulated in the risks the take.
15 - Franco
Nick, this is an outstanding opinion pieces and I concur with most all of it. Well-crafted outline with solid resoning in clear terms.
In your post #11 you add the following.
But in times like these, I think we have to be careful not to throw the baby out with the bathwater. Excellent follow up statement!
I would like to make the following correction to your next statement.
”Private markets are
oftenpredominately much more effective than government for providingmanymost all goods and services..And then this is another excellent follow up statment.
”The current situation has arisen from decades of poor regulation. So going forward, hopefully we will have better regulation, but that need not necessarily be more regulation.
I would also like to add that America it too diversified and creative not to survive, and will come through it better and stronger in areas it has been weak in. It needs the pain for the gain, this is good for us, its just that it is going to take much of the free western world with it on this ride. But then again, other countires too will need to make many of their own corrections.
Question: AIG was really the biggest surprise to me. Can you elaborate on what this means and what effects the markets an which markets we feel from this. Aren’t they not the largest insurance company in the world and didn’t they loose 60% in value?
16 - Nick First
Franco: thank you for the compliments and clarifications. I agree that America will survive this, but I think it will be a long time before we can return to business as usual.
Re: AIG - because the US Government essentially nationalized the company and assumed its liabilities, markets should be sheltered from much of the direct fallout from AIG (and AIG insurance policy holders will still be covered) which I believe was part of the Government's intention behind the intervention. However, it seems equity and credit markets will remain skittish as they speculate on which other companies have toxic assets on their books (the Government would likely let smaller companies fail). Also, the Government will need to begin to sell off AIG's non-impaired assets to pay down its debts, which could put another form of downward pressure on asset markets. The Economist wrote a good piece on this today
17 - bliffle
The US investment problem is not because people save little money (in fact, savings are the enemy of growth as they inhibit money velocity), the problem is disinvestment, which is the result of redistributing income from the low-income to the high-income, thus diminishing the economic multiplier. cf. "The Thrift Paradox" as it was known before macro economics.
Also, we have developed a peculiarly American mode of disinvestment in the common LBOs and holding companies that liquidate company assets for personal wealth and exhaust capital and retained earnings.
18 - cuervodeluna
bliffle, Let me save you all those words.
The problem was and IS: gringo greed.
19 - bliffle
Actually, I think it's human greed, as I haven't noticed that greed is restricted to people in any particular geographic location.
20 - Don Jarrett
This video on the subprime problem was recorded in 2007.
Comical -- but tragic.
21 - Nick First
The NYTimes blog Freakonomics posted a great FAQ of what happened to AIG and Lehman.
22 - cuervodeluna
bliffle,
I prefer to hope that there are some cultural groups less flagrantly promoting greed.
Where I live it's Mexican greed.
23 - bliffle
Seems like utter folly to expect Paulson, Bernanke and co. to bail us out of the crisis they've contributed to with such enthusiasm.
In fact, it seems like folly to prop up the institutions that are proven failures. There's no reason to expect they will do better if we give them a trillion dollars to cover their embarrassment.
In fact, it would be a lot cheaper to pump the money in at the bottom of the economy rather than the top. Maybe 12 times cheaper.
There's about $550trillion of money paper riding on $45trillion of real assets in the US, so that entire facade of paper is 12 times bigger than the underlying intrinsic value. We're operating on the same margin as in 1929.
So, instead of wasting the money on the paper facade it should be applied to protecting and enhancing the intrinsic value.
Instead of bailing out false front institutions we should be bailing out people who have lost, and are losing, their homes thru foreclosure. Every dollar we spend on our intrinsic value is like $12 spent on the paper facade.
Looks like a better deal, to me.
But then Paulson and Bernanke would be deprived of the pleasure of coppering their friends investments in paper. How sad.
Just think, instead of $1trillion we could do it with a mere $80billion or so. Thats just 6 months of Iraq warfare. Hell, that's not much. Chump change, as they say.
But maybe we'd be sending the Wrong Message. That intrinsic value, like real property, real work (you know, building and fixing things, etc.) is more valuable than being a Hedge Fund operator, and that might upset our whole aspirational system.
24 - Nick First
The trouble is, credit markets are locked up. That means banks won't lend to each other (because the fear they won't get their money back). And if banks won't lend to each other they won't lend to consumers or other businesses. That means business will have less money to invest and consumers will have less money to consume. This could bring our economy to a halt.
My understanding of the administration's proposal is that they plan to buy up the illiquid assets from the banks to help strengthen the banks' balance sheets, so they can start lending again, which is vital to the entire US economy.
25 - Nick First
For those looking for an articulate argument against the administration's proposal you might want to read this.