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What You Need To Know About The State Of Our Financial System

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https://www.tnr.com/blog/the-plank/what-you...inancial-system

Financial markets have stabilized--people believe that the U.S. and West European governments will not allow big financial institutions to fail. We have effectively nationalized any banking system losses, but we’ll let bank executives enjoy the full benefits of the upside. How much shareholders participate remains to be seen; there will be no effective reining in of insider compensation (my version; Joe Nocera’s view). Small and medium-sized banks, however, will continue to fail as problems in commercial real estate continue to mount. The economic recovery, in the short-term, may be surprisingly strong in terms of headline numbers; this is a standard feature of emerging markets after a crisis (e.g., Russia from 1998 or Argentina after 2002). Official short-term forecasts are probably now too low, as the IMF and other organizations make the case for continued fiscal stimulus and very loose monetary policy.

However, a two-track economy appears to be developing: One part will do well (e.g., around big banks on Wall Street), and another part will struggle (many consumers and firms around the world want to reduce their debt; the same thing happened in Japan’s “lost decadeâ€). During the 1990s, Japan had some years with good growth, but overall the decade was a disappointing deceleration of growth; the same could be true now at the global level.

Longer term U.S. growth prospects remain particularly uncertain--has consumer behavior really changed?; if finance doesn’t drive growth, what will?; is the budget deficit under control or not (note: most of the guarantees extended to banks and other financial institutions are not scored in the budget)? The implication, presumably, is higher taxes on the productive nonfinancial part of the economy--to pay for the implicit subsidies and ongoing rents of the financial sector. While many entrepreneurs understand and resent this math, they are strikingly unwilling to do anything about--or even speak out on--reining in the power of the biggest banks. Even the smaller banks--who have really been hammered by the actions of larger banks--are only just now figuring this out and beginning to express resentment; sadly, this is too late to make much difference.

There has been a great deal of attention recently on income distribution (WSJ; NYT), with the argument being that the long financial boom made some people richer and the bust is bringing them back down. But this misses the point that (a) some of the mega-rich will do very well; think about how Carlos Slim took over large parts of the Mexican economy after 1995, and watch Wilbur Ross acquiring assets in the U.S. today, (B) billionaires becoming millionaires is hardly something to get worked up about.

The real damage is for 10-15 percent of American society, mostly without college education, who lost jobs, houses, and education opportunities. The First Great Depression was a decade of effective poverty and other terrible outcomes for around 25-30 percent of American society. We have avoided a Second Great Depression but the social costs are still huge. Think through the political implications of that.

The collapse of Lehman Brothers in particular and the ensuing financial crisis in particular exposed serious weaknesses in our banks, insurance companies, and financial structures more generally. We were “saved†by radical central bank action and additional government spending. Over the past 20 years, crises have become more severe and more expensive to counteract. We are on a dangerous and slippery slope.

Yet there is no real reform underway or on the table on any issue central to (a) how the banking system operates, or (B) more broadly, how hubris in finance led us into this crisis. The financial sector lobbies appear stronger than ever. The administration ducked the early fights that set the tone (credit cards, bankruptcy, even cap and trade); it’s hard to see them making much progress on anything--with the possible exception of healthcare (and even there, the final achievement looks likely to be limited).

The latest New York Times assessment of financial sector reforms is bleak. The Washington Post is running an excellent series on exactly how and why the banks have become stronger (part one; part two). Big banks have risen greatly in power over the past 20 years and were already strong enough this winter to ensure there was no serious attempt to rein them in.

Financial innovation is under intense pressure in both popular and technocratic discussions, but does not face any effective regulatory controls (our view; Adair Turner). This is a dangerous combination. Unless and until there is real re-regulation of finance, repeated major crises seem hard to avoid. Wall Street responds, “we have changed how we behave,†but this must at best be cyclical--after any emerging market crisis, the survivors are careful for a while. But then they go on another spree and you re-run the same boom-bubble-bust-bailout sequence, in a slightly different form and with potentially more devastating consequences. The potential for serious crisis will not decline unless and until you change incentives--and this frequently requires a change in power structure (think Korean chaebol, Thai banks, or Indonesia under Suharto).

The consensus from conventional macroeconomics is that there can’t be significant inflation with unemployment so high, and the Fed will not tighten before mid-2010. The financial markets are not so convinced--presumably worrying, in part, about easy credit leading to dollar depreciation, higher import prices, and potential commodity price inflation worldwide. In all recent showdowns with standard macro models recently, the markets’ view of reality has prevailed. My advice: pay close attention to oil prices. The conventional oil market view is that there is plenty of spare capacity so we cannot experience the price spike of early 2008; we’ll see if this proves complacent.

Emerging markets, in particular in Asia, are increasingly viewed as having “decoupled†from the U.S./European malaise. Increasingly, we hear that Asia’s fundamentals allow strong growth irrespective of what is happening in the rest of the world. This idea was wrong in early 2008, when it gained consensus status; this time around, it is probably setting us up for a new round of financial speculation--based in part on a “carry trade†that now runs out of the U.S. Most Asian currencies are a one-way bet against the U.S. dollar over the medium-term, as they are already considerably undervalued and their central banks actively intervene to prevent significant appreciation. The appetite for this kind of risk among investors is up sharply.

What should we expect from the Pittsburgh summit on September 24-25? “Nothing much†seems the most likely outcome. The leadership of industrial countries does not want to take on the big banks, and the technocrats have contented themselves with very minor adjustments to key regulations (“dinky†is the term being used in some well-informed circles.) The G7/G8/G20 is back to being irrelevant or, worse, mere cheerleaders for the financial sector.

Overall, the global economy begins to recover, but the crisis created huge lasting costs for many poorer people in the U.S. and around the world. Recovery without financial sector reform and reregulation sows the seeds for the next crisis. The precise timing of crises is always uncertain but the broad contours are clear--just like many emerging markets over past decades, the U.S., Europe, and the world economy look set to repeat the boom-bailout cycle. This will go on until at least until one or more major countries goes completely bankrupt, or until a real financial reform movement takes hold either among technocrats or more broadly politically--and the consensus then shifts back towards the kind of much tighter financial regulation that was established after the last major global fiasco in the 1930s.

State failure, unless someone stops the banks.

Is anyone going to stop the banks?

No.

So, just state failure.

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I reckon we'll get one last hurah after this. Next year will be the double-dip (negative GDP growth), 2012 will be the housing market bottom and 2015, when a unit of debt produces no GDP growth, will be the start of the next mania phase. When that bursts, which could take 5-10 years, it'll be all over.

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I reckon we'll get one last hurah after this. Next year will be the double-dip (negative GDP growth), 2012 will be the housing market bottom and 2015, when a unit of debt produces no GDP growth, will be the start of the next mania phase. When that bursts, which could take 5-10 years, it'll be all over.

And when exactly can we expect the next prophet from god to arrive, you don't say.

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I reckon we'll get one last hurah after this. Next year will be the double-dip (negative GDP growth), 2012 will be the housing market bottom and 2015, when a unit of debt produces no GDP growth, will be the start of the next mania phase. When that bursts, which could take 5-10 years, it'll be all over.

bring forward to 2010 methinks

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The real damage is for 10-15 percent of American society, mostly without college education, who lost jobs, houses, and education opportunities. The First Great Depression was a decade of effective poverty and other terrible outcomes for around 25-30 percent of American society. We have avoided a Second Great Depression but the social costs are still huge. Think through the political implications of that.

really

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really

It seems to be the common view now even by some bearish commentators. But the common view 2 years ago is we will avoid a recession but have a slow down in growth.

From what I have read it is hard to argue we are not already in a depression.

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State failure, unless someone stops the banks.

Is anyone going to stop the banks?

No.

So, just state failure.

I make no forecasts regarding armegeddon, but I'll make one regarding this. If the banks carry on being both:

  1. Visibly greedy

  2. Visibly stupid

All the governments will be able to do is stand aside whilst the people string the bankers up by their necks from the nearest lamp-posts.

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From what I have read it is hard to argue we are not already in a depression.

This is my view, too. When one mentions economic depression, one is often met with an extremely emotional response. I consider it self-evident that we're in a global depression because economic activity has slowed significantly as a result of large scale mal-investment. I think it very difficult to assume that this is not a statement of fact.

A major problem with the concept of global economic depression is that no-one knows what the experience will be like. Mere allusion to the great depression is unhelpful as many factors (especially political factors) were quite different ~80 years ago. Furthermore, this period hasn't been one of particular popular historic interest, and those who experienced it first hand are mostly, now, dead.

I'm almost amused to the extent of open mirth at the idea that "we're emerging from the recession" - as the phrase conveys scant information... requiring a rather counter-intuitive notion of emerging as well as ignoring that a recession could only be claimed in the first place by an assumption that all economic downturns are part of the ordinary business cycle. A crisis in the financial sector during a boom is not part of an ordinary business cycle... and, as a consequence, if we hope to make meaningful comments, we must take into account that the cause (and hence effects) are very different to recessions in living memory.

Politicians are playing with terminology - this will, I suspect, fail to dupe a sufficiently large proportion of the population to establish the increased activity the elite crave. Time will tell - I guess it is always a mistake to underestimate the stupidity of the general public.

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You can only judge a depression from the rear view mirror. It is a little early to say one way or another, ask me again in 20 years <_<

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Would 15% down be a depression? (But, if so, then the US had another one in 2000):

How's the economy doing? There is a huge raft of statistical data to choose from, but how about this one: U.S. Treasury receipts from all sources. It stands to reason that they are a pretty good indicator of overall economic activity since they include income and corporate taxes, customs and excise duties, etc.

The chart below shows a 12-month running total (blue line) and the percent change from the year before (red line); they are down 15% for the period ended in August 2009. That's not to say that nominal GDP is down 15% - don't forget the increase in government spending (which piles on even more debt, of course) and the artificial boost to numbers from the shrinking trade deficit. But what this chart is ultimately saying is that, when it comes to the private side of the economy, then yes, it is more or less down 15% from a year ago.

15% Down

Peter.

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