Big Bust 2008 crushed residential housing and corporate assets. Moving ahead, commercial vacancies and $1.5-trillion in nonperforming loan rollovers are pushing society toward a years-long "Weekend at Bernie's."
Welcome to capitalism's greatest debacle: the Balance Sheet Earthquake.
DOWNLOAD NOW -- FOR THIS DIARY. 34 panels.
Dr. Richard Koo -- Nomura Research Institute, Tokyo -- offers a striking, singular contribution to Political Economy.
With John Maynard Keynes, Naomi Klein, and Nassim Taleb -- a foursome.
Dr. Koo shows how we flipped from normal "Yang" economics over to a fear driven "Yin" dysfunction.
Diary whisks in the Stimulus; the Great Depression of 1929; "St. Milton's Big Blunder," a.k.a. Monetarism; Corp.Class dishonesty; Phil Gramm, poisonous Tory shill; a timeline and career planning.
And how the Obama Administration is busting hump to get back from "Yin" to "Yang."
So simple that a GOPer could get it, or maybe not -- the new Econ_101 :::
The audio is 83 minutes. By way of background, Dr. Koo's family hails from Taiwan. He is an American citizen and started his career in America before hooking up with Nomura 20+ years ago.Preliminary info:
First: "NPL disposal" refers to Non-Performing Loans. Loans that are not getting their payments made, plus loans that are coming due for a "baloon" rollover but cannot qualify for it. Bad loans. The "disposal" process refers to doing massive write-offs so that corporate balance sheets are revalued at current market values. "Mark-to-market" is the accounting term for these revaluation processes -- which ultimately force "disposal" at auction or distressed sale for the bad loans.
Second: "GDP" refers to Gross Domestic Product. The value of all goods and services produced in a country for a given year.HEREis audio of Dr. Koo making a presentation of these PowerPoint panels to a professional audience.
Dr. Koo put his material into a book. "The Holy Grail of Macroeconomics."
From the book cover:
Richard Koo does it again. By presenting a unique theory regarding the great Depression and Japan's recession of the last 15 years. Koo offers a new understanding of current problems in the U.S. and other economies. With many pearls of analytical wisdom, The Holy Grail of Macroeconomics: Lessons from Japan's great recession is a must-read for economist, policymakers and individual investors alike. - Nobuyuki IdeiThe elevator-pitch economists' summary runs like this (and feel free to skip it):
Richard Koo's pioneering work on balance-sheet recession has been invaluable in understanding the difficulty faced by Japan's economy and monetary authorities during the past 15 years. In this book, he has shown that the U.S. Great Depression was also driven by the same balance sheet concerns of the private sector, indicating that this kid of recession can happen to any post-bubble economy. I sincerely hope that the lessons contained in this book are put to good use in fighting similar recessions elsewhere, including the U.S. subprime crisis. - Yasushi Mieno
The Holy Grail of Macroeconomics presents a brilliant and original framework for understanding-and overcoming-a post-bubble economic crisis such as the one the world faces today. By discrediting the conventional view that monetary policy is effective in combating a post-bubble recession, Richard Koo has made an invaluable contribution to economic theory and at just the right time. Only fiscal stimulus on a very large scale can prevent a severe global slump in the years ahead. This is an important book. It should be required reading for economic policy makers all around the world. - Richard Duncan
1. Following forced-excess booms, not so infrequently a country encounters an economic earthquake, followed by what Koo terms a "balance sheet recession." These recessions have completely different properties and treatments from normal business cycle recessions. Examples: today’s economic crisis, Japan’s 15 year slump, the Great Depression of 1929. Today’s crisis is especially serious because it is not just the U.S. but involves simultaneous and similar responses in other credit bubble economies such as the U.K. - plus the global impact of the collapse in demand has brought down even the surplus countries like China.The fleshed-out, longer length and more accessible discussion of the Koo PowerPoint runs like this:
2. The fall in asset values means the private sector must repair their balance sheets, which produces weak demand for funds and credit. Over years the reduction in loans outstanding -- termed "deleveraging" in the financial literature -- will be completed. But in the process the private sector shifts from profit maximization to debt minimization. Business profits and consumer surpluses are paid into the banking system instead of being spent or invested. (In the US this imbalance inflow-over-outflow averaged about $100 billion per month over the six months from September 2008 to March 2009). Normally this would support roughly ten times as much bank lending. Now the funds are trapped in the banking system due to the lack of demand for funds.
3. The sum of savings and debt repayments end up becoming a net leakage of funds out of the income-to-loans stream - which produces a deflationary feedback loop. More savings/loan_repayments
=> lower incomes => lower demand for credit. This looks like the Japanese Great Recession and, particularly, like the 1930-1931-1932 years of the Hoover Administration.
4. Repeat the adverse feedback until incomes (GDP) have fallen to a new equilibrium where the private sector is too impoverished to save. (And consumers have moved back to caves and taken to wearing untanned hides.)
5. In this type of recession or depression, the economy will not enter self-sustaining growth until private sector balance sheets are repaired. There is no intrinsic mechanism in a laissez faire form of capitalism that can cut in to make these repairs.
6. Monetary expansion along the lines of Friedman's Monetarism -- as developed by the Chicago School -- is ineffective. This is due to the blocked demand for credit flow. Additional liquidity injected to lending institutions by the Fed ends up in excess reserves (or is used to engineer buy-outs of banks that are not favored for the injections.)
7. What policies can reduce the damage done to incomes by the forced loan repayments (a.k.a., deleveraging) ? Two policies according to Koo: (1) fiscal stimulus, where the government borrows at low cost to spend the excess savings of the private sector. Japan’s experience demonstrated that GDP could be supported by sufficient government borrowing/spending — thus avoiding a catastrophic collapse in incomes. And (2) capital injections and "bailouts" directly into the Main Street financial system to heal targeted balance sheets.
Exhibits 1. through 5.
The world in March 2009. The Great Recession had kicked in during 2008 with major impact on the United States, European Union, China, and Japan.
Further, the Monetarist prescription to lower interest rates had been applied, but with no effect. Zero Interest Rate Policy (ZIRP) was in effect -- or close to zero -- everywhere but Australia, which had halved its bank rate. No effect whatsoever.
Features of the Balance Sheet Recession.
Here we get to Dr. Koo's working definition and a presentation of the unique problems that define a Balance Sheet Recession.
At this point Dr. Koo's presentation shows what happens if government does not take action:
Features of Balance Sheet RecessionThe language in Item 3. is dependent on jargon. Businesses are not borrowing, not investing, because the values of their assets have collapsed. They are trapped by the technical definition of bankruptcy. Real estate and stocks and bonds crater, while outstanding loans sit at face value. The result is that business balance sheets show them to be bankrupted or near it.
1.) A balance sheet recession emerges after the bursting of a nationwide asset price bubble that leaves a large number of private-sector balance sheets with more liabilities than assets.
2.) In order to repair their balance sheets, private sector moves away from profit maximization to debt minimization.
3.) With the private sector "deleveraging" [ = not borrowing, not investing; paying down debt ASAP to avoid being declared bankrupt], even at zero interest rates, newly generated savings and debt repayments enter the banking system but cannot leave the system due to the lack of borrowers. The sum of savings and debt repayments end up becoming the leakage to the income stream.
4.) The deflationary gap created by the above leakage will continue to push the economy toward a contractionary equilibrium until the private sector is too impoverished to save any money.
5.) In this type of recession, the economy will not enter self-sustaining growth until private sector balance sheets are repaired.
Many Main Street firms are ruined. One other factor is that Corp.Class dishonesty during a Big Boom will also run up there, off the scale. Such as Bernie Madoff and the George Anderson DUI killing of Florence Cioffi will leave ordinary citizens wary of the big spenders.
Mass marketing for consumer durables -- cars, refrigerators, furniture and the like -- becomes especially difficult because consumer financing is also dead in the water. They make their monthly loan payments, which economists count as a net "saving." Private citizens "save" money, but they are afraid to spend on new purchases.
Money flows to banks from loan repayments, but then sits idle in the banks -- blocked from the normal flow of payments back into new loans.
This capture of funds inside the banks is called "leakage" in economic jargon.
Banks come out of the "Bust" earthquake event effectively ruined, similar to Main Street. Their assets -- as with other businesses -- are devalued from the boom peaks. Their liabilities remain at full face-value-of-contract force. Hiding the liabilities with such as CDO/CDS shells ??? Useless in an earthquake. Even when the government does capital injection, the banks know that their loan making processes are in trouble because additional devaluation will make any new loans suspect/bad.
Exhibits 7. and 8.
Loan demand has tanked. Meanwhile, from 2006, Ben Bernanke at the Fed had said that "there is no housing bubble."
This root Bernanke lie is exposed: the housing bubble is illustrated with divergence of the ratio between sale prices with rents.
Exhibit 10. Americans Spent $1.5-trillion that Should Have Been Saved.
The shocking extent to which the Bush Boom induced irrational spending. Savings fell with a net failure of $1.5-trillion dollar shortfall between 2003 and January 2009. The Bush tax cuts did not recirculate into productive use.
The historical standard is that savings must hold near 4% to finance our "Yang" savings-to-investment flow. 4% yields near to full employment.
Instead of money going to middle- and lower-class households that need to save money, the Bush tax cuts went to the wealthy. You can see what happened.
Every public claim about these tax cuts made by the GOPers... failed.
THE GRAPH IN # 10 SHOWS WHY WE HAVE UNEMPLOYMENT AT 10%.That 4%-per-year saving rate is what finances new infrastructure, new businesses, new R&D, and all the goodies that make for a healthy real-goods economy.
The healthy Yang investment cycle would have taken these savings and returned them to useful purposes. Adam Smith's competitive economics will work.
However, there is no such thing as a free lunch. That is the rule did not apply to the lives of George Bush or his merry band of NeoCons, Rove-led hypocrites, and the self-named "Vulcans." Not in their personal lives. Not in their decisions in positions of responsibility.
For everyone outside the Richistan clubs, that 4% saving rate is the obvious be-all and the end-all for generating jobs in sustainable, productive enterprises.
Inside Richistan, what we got was conspicuous consumption. The stuff of Thorstein Veblen and his book The Theory of the Leisure Class, first published in 1899. Dr. Veblen was a Norwegian-American who taught at the University of Chicago. His brain was claimed, personally, to be made of two wooden parts. His talent was to grab the plain facts and then to show through Political Economy their effects on society.
Veblen was as much a sociologist as an economist. Maybe more so. Interesting read for 110 years having passed.
# 10 is pure Veblen, of whom you will never hear mention from the shills. He did not exist. Google books has The Theory of the Leisure Class. Same for Amazon, out of Penguin Books new for $12.
AMAZON-- for The Theory of the Leisure Class.
Bush and Bernanke ran the American economy into the ground with their anti-savings policies. For example: the war deficits were not paid in taxes, but by kiting bond-checks overseas. Zero Interest Rate Policy (ZIRP) out of The Fed led to profligate consumption instead of following the normal route to investment. One head-knocker Richistan fact is that 40% of the value for new home construction for 2004-2007 went to second-home vacation houses. (Up from 8%.)
Their party was going to go on for ever.
$8-trillion in U.S. Federal debt came to held overseas due overwhelmingly to the Bush Administration -- some party.
An aside: I would also be interested to see what Dr. Koo thinks of a simple Marx-and-Veblen extension into factor analysis, for this drop in the saving rate. To wit: how and to what extent does distortion of income distribution -- giving much more to the already wealthy -- affect the fundamental savings rate ??? Evidence from these Bush years indicates that the wealthy didn't save squat.
Apparently, when the rich get to be a wide multiple better off than average citizens, they lose the incentives to save for future advancement. They have been transported to a Richistan Heaven.
To me, using my slide rule and a TI-83i graphing calculator for a rough cut, it doesn't seem possible for the weakened middle- and lower-income classes to save enough during the ordinary Yang phase of the business cycle to make up for such a shortfall.
The Bush tax cuts went to every Richistan use except for saving.
The doctrines of Ronnie Reagan's "Trickle Down" supply-side economic propaganda are shown, finally, in these 2003-2008 data to be obscenely false.
The political fall-out of this $1.5-trillion dollar shortfall in savings ??? The worst of it for the GOPer shills should be that this saving/investment gap and the resulting fall-off in employment are the effects ONLY of implementation of their income redistribution doctrines.
Democrats need to hammer it in.
These was also a parallel Corp.Class Dishonesty disaster that merits attention. This is what Senator Brian Dorgan (D-ND) complained about -- opening the financial doors for criminals -- when the Phil Gramm (R-Hell) "reforms" went through. When Glass-Steagall was in effect, the very scale of bad loans would have been a practical impossibility. The worst of the #$(*&^% Gramm-Leach-Bliley disaster was opening the doors for mass fraud.
Repairing the Gramm blunders will limit future criminality. That will be a difficult political problem, as Glass-Steagall limits corporate profits. At least we can see a solution, which is not the case for getting back to a 4% overall saving rate. Pernicious effects of income concentration -- a very tough problem, indeed.
All you have to do is to take a look at the raft of over-the-top Donald Trump projects and you'll get the pattern. Projects that are distorted to be of, by, and for the rich are long-term losers -- hypersensitive to these boom-bust business cycles. And what is the employment impact of these projects ??? Minimal compare to ordinary small-business or small-cap companies.
For one first-rate example: you can google [ liberty national golf course ] for a functional definition of investment insanity. This project is typical for Trump's patch of Richistan. Plus, on top of the hundreds of millions spent to build one 18-hole golf course, the putting greens at Liberty are contoured specifically to be more difficult than Augusta National. After watching the pros play there, Liberty looks to me to be virtually unplayable for amateurs.
If we're going to waste a substantial fraction of our investment money on Trump/Richistan projects, the savings rate to maintain full employment will have to be higher than the standard 4% figure. How much higher ??? No way to know without substantial econometric analysis.
Exhibit 11. Japan’s GDP Grew even after Massive Loss of Wealth and Private Sector Rushing to Pay Down Debt.
Public spending in Japan from 1990-2005 drove more-or-less steady increases to the Gross Domestic Product (GDP).
This graph puts the lie to another GOPer propaganda meme. The fact is that public investment/spending work exactly like private investment/spending. Clearly, with private investment/spending in the toilet, the Japanese economy was kept afloat with public money.
Look at the numbers. There is no truth, no way that the public sector rides on the back of the private sector. The private sector is not the great shark swimming the great ocean, with the public sector a little sucker-fish remora stuck on the under belly.
Economies do not work that way.
Projects can be highly productive in both sectors. For example, the Hoover Dam and the Grand Coulee Dam electrified half of California. Hoover was designed and sited by the Department of the Interior and the engineers of the Bureau of Reclamation. Add in the public water projects and you get the modern Southern California -- which would have been impossible operating in a private-only economy.
Private sector projects can have similar impacts: the automobile assembly line, for one example. Innovations occur in both sectors.
The clear truth is that public and private expenditures work exactly the same way. They have the same multiplier effects on direct income. They have the same kinds of distributions for effectiveness of long-term investment -- with public investments tipping the scales more for the long-term impacts. Taxes and savings deposits raise dollars: same effect, exactly.
Dr. Koo explains the mechanisms in the audio presentation.
Exhibits 12. through 17.
Balance Sheet Problems Forced Japanese Businesses to Pay Down Debt even with Zero Interest Rates.
That's the title off # 13. This group of slides demonstrates that the Invisible Hand of capitalism's gods touched these island-dwelling mortals beginning in 1990 and removed $15-trillion of asset valuation, which equaled 3 years of Japan’s GDP. Our difficulties in 1929-1933 recorded these same gods giving out a haircut worth 1-year of our 1929 GDP.
Businesses curled up in their shells.
Asset decline forced businesses to pay off their debts. Land values tanked. Share prices tanked. Contracts stayed the same.
Leases and mortgages had to be paid.
Even with money on the lend at zero interest, businesses had to pay off their debts to survive. Private sector was not borrowing. (Dr. Koo does not mention that Japan also invoked severe bars to foreign investment. If they hadn't, new businesses could have formed using foreign capital to great advantage.)
The public sector took over. In fact, public sector spending produced both rises to GDP and stability for tax revenues. There were two exceptions -- breaks to public spending -- that disturbed orderly recovery.
Exhibit 18. Premature Fiscal Reforms in 1997 and 2001 Weakened Economy, Reduced Tax Revenue and Increased Deficit.
-- Hashimoto fiscal reform
-- Koizumi fiscal reform
Essentially the Japanese counterparts to Hooverites and Monetarists forced breaks to stimulus spending.
Private sector new-investment activity had remained tanked. Contracts with inflated price tagged were still the tail, wagging the dog.
The immediate effects, both times, ran back to lower employment and lower tax revenue. Indeed, Dr. Koo shows that cutting back stimulus spending caused added deficits -- unnecessary deficit: ¥97.6 trillion.
This effect is to be expected during the Yin phase of the business cycle. What else, with business tied in knots with their balance sheet problems ??? When government failed to replace the Yang savings-to-investment flow with Yin direct stimulus, the economy headed back toward devaluation immediately.
Exhibit 18. needs to be printed on tee shirts. Then shoved into the pie holes of the Fool GOPers, who propagandize that stimulus spending will "bankrupt" the country by causing massive deficits.
Stimulus spending, alone, is what keeps Yin-phase tax revenues at reasonable levels.
Now comes The Holy Grail....
Exhibit 19. Four Kinds of Banking Crises and Their Remedies
Type (I): 1989 S&L crisisYou won't see a hint of this logic from the "fresh water" Chicago School economists. Nothing I can find from Dr. Milton Friedman. Nothing from his followers. A DKOS diary is not the place for extended analysis of economists' failing... but beware these guys -- they convinced themselves that a passive Monetarist policy would have resolved the Great Depression.... (The sun would have burned out first.)
Type (II): 1982 Latin America debt crisis, nationwide credit crunch in the US between 1991 and 1993, and the Nordic banking crisis in the early 1990s
Type (III): Japan prior to 1995 (for example, problems at two credit cooperatives)
Type (IV): Japan since 1996, Taiwan since 2000, the US Great Depression of the 1930s, and US and UK subprime crisis since 2007
Monetarism had started out with statistical work rooted entirely in Yang phase periods. Unfortunately, Friedman and his followers also claimed that their fine-tuning measures could be expanded, magically, with similar effects during post-earthquake distressed periods. That is a major blunder.
Look at the data in Dr. Koo's graphs, moving ahead from #20 to the end..
Monetarism is irrelevant during the Yin phase. Businesses couldn't have borrowed normal flows of money for new projects, if the government was paying them a percentage point to take it. Businesses are technically bankrupt, or so burdened with zombie contracts that new projects are impossible.
Keynes hit this nail on the head.
He argued that deflation is inevitable without government intervention. The arguments didn't have PowerPoint graphs. Macroeconomic data collection was at its infancy. Also, Keynes's audience were the industrialists and bankers, so his idea that contracts are "sticky" was cast to the agreements related to labor rates.
Of course, for stickiness, mortgages and commercial leases are to labor rates as Super Glue is to Jello.
"If the fall of wages and prices goes far ... those entrepreneurs who are heavily indebted may soon reach the point of insolvency." Deflation after the Balance Sheet Earthquake is what causes the epidemic of bankruptcies.
Exhibit 20. Two Capital Injections Ended the Credit Crunch in Japan
This graph speaks for itself.
One note: the phrase Capital Crunch has to taken apart from the overall economic situation.
This is the Type (III): Japan prior to 1995 (for example, problems at two credit cooperatives). The big Yin-forcing crisis began with a simple Credit Crunch. When there was insufficient Capital Injection in 1990, matters headed down the hill.
BTW: I apologize for not doing a detailed analysis of # 20. That is one complicated graph. Or three simple ones.
Exhibit 21. Percentage of (U.S. residential) House Purchases that May Lead to “Return the Key”
Here you see the Underwater Mortgage risk as of March 2009. Do imagine the balance sheet impact on U.S. banks if some 28% to 43% of mortgage loans bellied up.
Exhibits 22 through 30
Economic strategies analyzed in # 22. The Monetary Policy elements are emergency actions.
# 23 shows the trade deficit experience for the U.S. That is the thick blue line at the bottom. You have to see it to believe it.
# 24 is for Japan. Thjis reiterates the impotence of monetary policy and/or loan availability during the Yin phase.
# 25 to # 30 are mainly for economists. Nothing critical to this diary.
Exhibit 31. The Anatomy of Balance Sheet Recession and Its Cure
-- A Balance Sheet Earthquake has occurred. Private sector is burdened with zombie contracts written at inflated prices.The Holy Grail.
-- Private "savings" are forced with either taxes or loans.
-- Government Procures Funds at Low Rates due to the Lack of Private Sector Borrowers.
-- Fiscal stimulus flows into the economy. This prevents further weakening and further deflation of assets.
-- Government Borrowings Help Maintain Money Supply in the Absence of Private Sector Borrowers.
This is a solid Flow Diagram that shows where government intervention cuts off the deflation-driven decline and multiple bankruptcies.
(How do you tell a GOPer shill ?? They can't read this graph.)
Exhibit 32. Yin Yang Cycle of Bubbles and Balance Sheet Recessions
Exhibit 33. Contrast Between Yin and Yang Phases of a Cycle
Summaries of everything you've seen above. Wonderful material. Notes to assist:
-- Fallacy of composition: thinking that what is correct for one business or one bank -- in isolation -- is automatically what you want to do for an entire economy. Classic example: what Hoover's Cabinet recommended in 1929-1932.
-- Saving as "Vice" and the Paradox of Thrift: this is a Yin phase problem, where spending to generate economic activity is the Prime Directive. Short-term saving by individuals will reduce the money supply in circulation, along with dampening retail activity.
-- NPL disposal: writing off Non-Performing Loans. The 1982 Latin Debt Crisis was resolved by allowing banks to hold these bad loans for a decade and more, till they could be written off without an earthquake.
-- Fat spread: refers to the rate differential between interest-paid-on-savings-deposits and interest-received-for-loans. That is the spread. A "fat" spread is just a larger than normal spread, where banks are more than usually profitable.
-- Bubble: -snark-.
Time Line: compared with what happened in Japan, the Obama Administration has worked wonders. Business loans are recovering. The combination of capital injection and Wall Street stimulus looks, today, to be working as intended. Main Street stimulus is in line to receive the returning TARP funds, all for the better.
Official statements out of the White House are predicting that unemployment will level out in April, 2010. TARP funds are likely to be recycled to maintain stimulus levels. That will move unemployment back to an 8% rate by end of 2010. Improvements through summer and fall of 2010 will impact the November elections in favor of Democrats.
The detailed actions of this Obama Administration have done about as much as is humanly possible to move the financial and heavy industry sectors toward the Yang phase environment. Employment efforts will now be introduced on a plan that puts mid-2010 as the high water mark.
One personal factor: if you choose a career path that is committed to one type of job, or one sector, then make sure that you prepare a backup job path. Learn some accounting. Do some teaching. Get at least some experience with a trade. You do not want to find yourself in the shoes of long-term Wall Street back office people, today. Too specialized. Too skilled. Their companies swallowed up and their jobs eliminated forever.
You may well need a backup career path. These busts can hit specific localized industries, all but wiping them out. There is nothing in capitalism to protect you from a bust.
Now, if you have studied this Diary diligently and checked out the graphs, you understand the balance sheet processes of economic earthquakes better than a substantial number of the individuals over the years who have won a Nobel Prize for Economics.
Now, let's hope that Kossacks put Koo's and Veblen's and Keynes's books on their reading lists. As a guess, you've already visited with Naomi Klein and Nassim Taleb.
So simple that even a GOPer can grok it !! -- or not. Republicans have focused since the early 1970s on attracting voters who operate on emotions instead of Inductive Logic. Today's GOPers are weak at analyzing weak vs. strong evidence, as well as seeing the underlying structures of arguments. They have never seen an Informal Fallacy that they didn't like. They are weaker with economics, thanas they are with Global Warming.
Understanding that capitalism is not working in a Type IV crisis -- the aftermath of a Balance Sheet Earthquake -- is not going to fit into the GOPer brains. Instead, these party line GOPers would have the country follow the Hoover Administration and the Monetarists down into a balance sheet-driven Depression II.
In contrast, based on the ordinary low-flame discussions here, Kossacks can read through this diary, understand Dr. Koo's central points, and apply this knowledge to what is going on. The new Econ 101.