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Sooner Fed Bail-outs Than The 1930s Revisited

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Sooner Fed bail-outs than the 1930s revisited

Put a clothes peg on your nose. The moral stench of bail-outs for the über-rich will be sickening. None of us wants to pay a farthing to rescue the bankers and assorted debt pimps who got us into this financial mess, and in doing so exposed our societies to such harm.

Yet we must forbear. It was such sentiments that turned the 1930 recession into a slump. "Liquidationists" prevailed: they insisted with Puritan zeal - or malice - that speculators should be driven to the wall amid a cathartic purge of the Roaring Twenties.

Among them were top bureaucrats at the US Federal Reserve and some of Europe's central banks. The consequence was the Brüning deflation in Germany, ushering in the Nazis. Democracies snapped across half of Europe. If it had not been for the towering figure of Franklin Roosevelt, America might have splintered into a bedlam of Prairie populists, Coughlan Fascists and Huey Long extremism.

We should be thankful that the man now heading the US Federal Reserve - Ben Bernanke - spent his early career immersed in the details of that catastrophe. He has written books showing how a credit crunch can set off a vicious downward spiral, and do so with lightning speed. You do not mess around in such circumstances.

The "liquidationists" accuse Mr Bernanke of taking a dangerous gamble with inflation by slashing rates from 5.25 per cent to 2.25 per cent in six months, culminating in a trenchant three-quarter point cut Tuesday. They accuse him of "moral hazard" for invoking a Depression-era clause permitting the Fed to take on $30 billion of direct credit risk left by the wreckage of the US broker Bear Stearns.

They are right, in a sense. This is probably the start of a massive taxpayers' rescue of the banking system. It stinks. But imagine if Mr Bernanke had listened to such advice as Bear Stearns faced collapse.

It is America's fifth biggest investment bank. It has $13,400 billion of derivative positions, and has underwritten $491 billion in options contracts. Topple this domino at your peril. It risks a chain of cross-defaults through the entire "shadow banking system", that vast untested nexus of paper commitments.

Bear Stearns had a liquidity cushion of $17 billion early last week. It vanished in two days. This was a run on a bank by New York insiders. It would not have stopped there. If the Fed had not taken emergency action on Sunday night, wolf packs would have fallen on Lehman Brothers (even bigger) with equal ferocity this week. The crisis threatened to snowball out of control.

America is not facing "recession-as-usual". It is in the grip of a property crash. House prices have fallen by 10 per cent so far; Goldman Sachs fears they may fall by 30 per cent in the end. The sub-prime mortgage industry has already disintegrated. Some 241 lenders have gone bust, or shut their doors.

The crisis has since spread to prime mortgages. Fannie Mae and Freddie Mac - the fortress agencies that guarantee 60 per cent of America's $11 trillion mortgage market - began to crumble last week. Even bodies standing at the top of the credit system are no longer deemed safe. As Barclays Capital put it, this was a "tsunami event".

Or in the words of City veteran David Buik at Cantor Fitzgerald: "No one in living memory has ever seen a banking crisis like this. I am older than God, and the outlook has never looked as bleak."

Any smug assumption that this will remain a local American affair may soon be confounded. The IMF has abruptly changed its tune. "Obviously the financial market crisis is now more serious and more global than a week ago," it said on Monday.

Property booms will soon be deflating across the Anglo-Saxon world and the eurozone's Club Med belt. Japan is already on the brink of recession. Debt levels are higher now in most rich countries than they were in 1929. The levels of financial leverage are greater.

As the Bank for International Settlements wrote last year, we are more vulnerable to a 1930s dénouement than people realise - should the authorities botch the response.

Like some other free-market bears, I now find myself in an odd position. For years we castigated the central banks for inflating a reckless credit bubble by holding interest rates too low. Now we have flipped. We are on the other side, defending monetary stimulus, even defending the state takeover of Bear Stearns debt.

No doubt we will have to defend yet more egregious intervention by the state before this is over. We will become temporary socialists.

Too bad. The world is in deep trouble. Purist ideology has become a danger. The "liquidationists" must be countered, and defeated.

When the dust settles, we can revisit the burning question of how we got here. We can try to remember that the time for tough love in monetary policy is at the start of a boom, not the end. We can administer condign punishment in Mayfair and Westchester County later for what has happened.

If it is any comfort to hard-liners, Bear Stearns shareholders have just suffered a 99 per cent haircut. Our own Joe Lewis has a lost a billion dollars. Satisfied?

And check out this comment from Karl Denninger of Market Ticker Forum, especially 4)

Here's reality, whether Ambrose (or anyone else) likes it or not:

.

1. You can't keep the price of homes levitating. The historical safe maximum home price is three times annual incomes, on average (in America; this has much to do with our tax code as well as mortgage interest is deductable.) You need 20% down, a 30 year fixed mortgage, and a "back end" ratio of no more than 36%. Any loan beyond that is unsafe, and there is 100+ years of history proving so. You cannot repeal the laws of economics.

.

2. The firms that committed the blatant fraud - yes, fraud - in telling investors and home buyers that (1) was not true must face the music. If they do not, then we will simply get more of that behavior, but the "common man" with a house he cannot afford will still get screwed.

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3. The Fed's claim that this was for "orderly markets" ignores the fact that in fact people place bets in both directions in the market every single day. By interfering with that market The Fed has created losers **who bet the correct way** and created winners out of people **who bet the wrong way.** Oh, and, apparently, has effectively given away more than a billion worth of real estate without a public bid. In the real world we call this "a taking without compensation" and its Unconstitutional in America. Expect this to be litigated, and it should be.

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4. Accounting has a simple answer to the valuation of an asset you can't get a price for - its zero. Tomorrow it might not be zero, but today its zero. This is a matter of both common sense and law. The banks have created these "off-balance sheet vehicles" to avoid this inconvenient fact of accounting. In other words, they have done this to defraud both regulators and the public. This must be stopped.

.

In reality we are facing a crisis of confidence. You can not force people to lend nor can you make a non-creditworthy person credit-worthy by other than increasing their income and/or decreasing their expenses.

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Until we have TRANSPARENCY and TRUTH the markets will not clear.

.

"The Slump" happened not because there wasn't enough intervention but **because, just like today, there was lack of transparency and outright fraud.**

.

We're headed straight for a re-run until and unless the regulators do their job.

Posted by Karl Denninger on March 19, 2008 12:41 PM

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A bit of background info, which may or may not be of interest. According to Yanno on market-ticker, AEP is very well connected to the establishment, including the security services. Given that he is pushing the bailout "plan", one might wonder if this is what at least one part of the establishment wants or believes necessary,

Peter.

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Before they use a penny more public money to bail out the banks, I think they need to impose some sweeping changes on the banking sector. We are seeing very clearly that they cannot be left to their own devices. It's a 'free market' when there is easy money to be made, but requires intervention on the way down. Time for a change.

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So euro-bashing Ambrose Evans-Pritchard reveals himself to be in the "privatise the profits/socialise the debts" camp. No surprise there then.

What a t urd.

AEP has a point to the extent that if another Great Depression is avoidable, then everything possible should be done to avoid one. Those who are old enough to have spoken to people who went through the Great depression will know why - it really was a terrible, terrible time.

On the Other Hand, I think KD is correct in his comments. Not only is a bail-out unhealthy in terms of moral hazard, it is also likely that it won't work and will just make the situation worse. Sooner or later we are going to have to bite the bullet.

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AEP has a point to the extent that if another Great Depression is avoidable, then everything possible should be done to avoid one. Those who are old enough to have spoken to people who went through the Great depression will know why - it really was a terrible, terrible time.

On the Other Hand, I think KD is correct in his comments. Not only is a bail-out unhealthy in terms of moral hazard, it is also likely that it won't work and will just make the situation worse. Sooner or later we are going to have to bite the bullet.

Good post, though I suspect the threat of "another Great Depression" is being increasingly trotted out to persuade us that reckless financial institutions should be bailed-out by massive injections of public money.

As you say though, such a course of action is unlikely to work, being just a mechanism to allow technically bankrupt and recklessly managed organisations to recapitalise their balance sheets.

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Good post, though I suspect the threat of "another Great Depression" is being increasingly trotted out to persuade us that reckless financial institutions should be bailed-out by massive injections of public money.

As you say though, such a course of action is unlikely to work, being just a mechanism to allow technically bankrupt and recklessly managed organisations to recapitalise their balance sheets.

To test my understanding of things, can I clarify what is going on at the moment? That is, we aren't seeing massive injections of public money, but massive loans against dodgy collateral. And the people who say that this is not right are saying it because these loans do not address the real issue which is that banks need to recapitalize; it merely hides the problem by letting them pretend that they do are properly capitalized, because they don't have to face the issue of the real worth of their dodgy assets.

So, until/unless we have a proper bailout (or something else), this crisis will continue,

Peter.

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AEP has a point to the extent that if another Great Depression is avoidable, then everything possible should be done to avoid one. Those who are old enough to have spoken to people who went through the Great depression will know why - it really was a terrible, terrible time.

And for anyone else have a read of The Grapes of Wrath.

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Before they use a penny more public money to bail out the banks, I think they need to impose some sweeping changes on the banking sector. We are seeing very clearly that they cannot be left to their own devices. It's a 'free market' when there is easy money to be made, but requires intervention on the way down. Time for a change.

Absolutely. I was thinking last night (never a good plan..) - as far as financial services goes, the whole concept of the limited liability company should be abandoned - the shareholders of banks should be on the hook for *all* liabilities should the bank collapse, and the employees should all be given shares in proportion to renumeration which they are not allowed to sell even when they left the company. That might focus a few minds!

Transaction taxes (Tobin tax?) could be used to make more extreme leverage unprofitable, possibly. And the whole network of offshore financial centers/tax havens should be closed down, by sending the odd gunboat around if required. Might sound extreme.. but if you use the general services of a country to make profits there, you should contribute back in taxes. And there's the whole terrorist/drug deal aspect of those centers.

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Yet we must forbear. It was such sentiments that turned the 1930 recession into a slump. "Liquidationists" prevailed: they insisted with Puritan zeal - or malice - that speculators should be driven to the wall amid a cathartic purge of the Roaring Twenties.

Among them were top bureaucrats at the US Federal Reserve and some of Europe's central banks. The consequence was the Brüning deflation in Germany, ushering in the Nazis.

So the Nazis will be back if the taxpayers don't bail out the speculators? Scary.

And they call us scaremongers.

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I have to agree with AEP. The banks need to be taken over or their share price crashed so they can merge as part of another entity. Money supply has to continue, no matter watch.

I've read grapes of wrath. My wife is American. I have spoken to her grandparents who lived the Great Depression. It was a really, really horrible time that still scars them. Trust me. These last few months have pushed us very close to a systemic breakdown. You may disagree with their actions, but the FED moved very quickly and prevented a full a full on rout. I wish our own government had been as decisive with Northern Rock (a far smaller company that has created far bigger public liabilities).

Frankly, I won't give a toss about moral hazard or inflation stats if I am queuing at a soup kitchen and living in hooverville.

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Before they use a penny more public money to bail out the banks, I think they need to impose some sweeping changes on the banking sector. We are seeing very clearly that they cannot be left to their own devices. It's a 'free market' when there is easy money to be made, but requires intervention on the way down. Time for a change.

Agreed 100%.

Clearly, we have no option but to bail out these idiots to save our way of life.

However, the price should be much tighter regulation of the banking system (proper regulatory authorities with real teeth) and investigations should be carried out to see who has breached existing regulations in the course of the last few years.

No way should the load of greedy idiots who double-dealt us into this mess walk out of this unscathed.

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  • 295 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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