This isn't your father's recession, or as Krugman quipped about 2001 your grandfather's, it is a panic from the 19th century, where a house of cards comes completely unraveled with a bank failure. The fall of Lehman will be the precipitating event for the panic of 2008. Traditional options are dwindling. And Paulson is fiddling while Rome burns.
It is a panic. The Dow is crashing as I write this. Though it is bouncing back, The pressure to do something is enormous.
How those worked was that banks would lend on some new venture, trade paper back and forth, and then one would go bust. Like Lehman Brothers, for example, then all the criss-crossed agreements would unravel, people would engage on runs on the bank, holders of stocks would dump them to cover the real debts. Right now the belief is that PIMCO and others who insured Lehman's defaults are selling. The even step nature indicates that this is not waves of sell orders coming from many directions, but a dolloped out selling. Someone is selling, and walking away until the next day, so as not to shut the market down. In 1987, waves just kept coming, and eventually the market ground to a halt as it was impossible to process them all.
This is an orderly panic. And it marks the end of the world that everyone reading this has known. Perhaps we can muddle through this one without fundamental change, by printing paper and then standing in place. But in reality we need to make changes, and dramatic ones. We need to green the American spirit, because it is not green supply, but green demand which is the key. If people want black things, then "alternative" energy is more expensive old energy. If we want green things, then oil is a boutique fuel for specific purposes.
Yesterday's rapid sell off at the end of the day in New York brought the collapse in share prices full circle. coordinated rate cut did nothing to budge the frozen credit markets which are dependent on recycled petrodollars. The credit crisis is not over, until the petrodollar holders say it is over, or until the Democracies act in concert to change the direction of their economies. This is not about green collar jobs, but about the greening of the developed nations to their spirit.
This collapse is being driven by large players, because it is not coming in waves of selling where one person sells and then another is forced to. It is coming in very discrete jumps. This means that it is a few players who know the limits of the system dumping, and then coming back the next day. The world's equity system is like a bank, and there is a run of one or a few large depositors on that bank. The generally belief is that it is those who backed Lehman debt.
Not only is John McCain meltingdown, and brings the Democrats within shouting distance of 60 in the Senate, but the oil patch bust in Canada may prevent the Conservatives from getting their coveted majority government.. The political fall out is likely to reverberate across elections and take many forms.
But these calculations must stand aside the most crucial step, and that is to cast off the fetters of oil as a previous era cast of the barbarous relic of gold. To do this means to inject fresh dollars into the banking system backed by something. That something, in 1933, was assets on the books. That something in 2009, must be revenue streams. From inflationary silver, the world turned to deflationary gold, from gold, to assets. From assets to revenue.
The reason this is essential is that, but for various tricks with mirrors, we now have deflation. That is, counting the losses of the housing portion of assets, the consumer is facing deflation, and the asset buyer is as well. Why spend today, when when money can be put under the mattress of short term t-notes? That's the problem, there are parties that are breaking the global equities piggy bank, and there s no reason for anyone to invest until the bloodbath is over. Why lend to your competitor today at pennies on the dollar, when you can buy him for pennies on the dollar tomorrow?
Te solution then is to take the money out of Paulson's hands, give it to the FDIC with a simple mandate: buy up banks that are not lending, and then start lending in an ever widening circle between them. "Too sick to lend, is too sick to live." This should be the mantra. Banks lend. If they stop lending, they aren't banks, but electronic bricks.
The way to manage this transition is to flood the world with short term US debt, forcing up short term rates, and then both forcing money out of treasuries, and giving a supply of money to directly lend as an asset base. The FDIC, and not the treasury, should take over banks which are clogging the system, and complete the clean up of toxic waste by a simple expedient: cram down CDS holders to the amount of default insurance that could have been afforded based on they can pay going forward.
As the FDIC insured deposits and subjected banks to examination and control, so to must the new era realize that we are now insuring equities, and thus must charge for crash insurance.
However, to have the revenue going forward, we must create activity to go with this revenue, but it must be activity that will move people to engage in commerce. There has been a great deal of focus on "green collar jobs" but most of these consist of subsidies to make energy more expensively. We have "green collar" jobs which involve "clean coal," which is as much of an oxymoron as "clean soot."
This panic means that the market is saying that everything we have done in the last decade: Iraq War, billionaire building, Homeland Security, Credit Bubble and Housing boom, is worth nothing. The past is being discounted, and only the future has any value at all. It is green demand. That is we must want thing that can be supplied with less carbon. Once we want those things, or demand is directed towards them, green supply of the right kinds can be invested in, and there will be economic activity and jobs that come with that. It's next step is to admit that everything done in the age of Reagan, was only buying time. Japan is now inching closer to the lows of the 1980's. You know, back when people thought that REO Speedwagon was cool. When you could start a fight over VHS and Beta. Those 1980s.
The problem then, is lack of investment supply. Not enough businesses that can pay the real cost of money. While Barry is right about the need to fix the problem, the LIBOR spreads don't suggest lack of credit confidence, they suggest deflationary expectation.
The paralysis in Washington is obvious. In effect, what should be done is as soon as the dust settles from the election, the newly elected President should take power. This can be done formally, by resignation of the Vice President, appointment of the President elect, his approval by the Senate, and then the resignation of the President. Or it can be done informally. But each moment that the white haired madman in the White House clings to power, is another moment that cannot be replaced. Each day like today means trillions of dollars are evaporating, and it will begin bankrupting otherwise healthy institutions who will then have to be bailed out in turn.
If not, the Congress might well show some sense, and do what ought to have been done, and ram through an impeachment. Conviction is more sanity than the public can muster. That would be the threat to Bush to comply: leave and you leave clean, stay and we will impeach you, and humiliate you before history.
At that point the plug will be pulled on interbank lending by the bid process, because the government will own the banks, and will lend. But we are in the deflationary expectation trap: why spend or loan a dollar today, when tomorrow it will buy a great deal more? Liquidationism was part of what created the Great Depression, but a great deal of the old needs to be liquidate. Either this will be through bone crunching deflation, or it will be by creating an monetary system which can expand with a much broader range of economic activity. Part of me wishes that JKG had lived to see this and chuckle.
This is a new epoch, until now the Fed sanitized inflation, and Congress and the President were free to spend. The deficits came at the price of higher interest rates, but we allowed some interest rates to be subsidized, namely housing. Housing was over-developed because it was under priced. Now the Fed is going to have to have interest rates pegged low, because of interest on the deficit, the need to keep housing propped up, the need to directly loan, and the need to provide such stimulus as can be had. Therefore, the fiscal authority will have to control inflation. One reason that politics had been so polarized is that theose who controlled the treasury could rob everyone, to pay their constituencies with pork. When this decade we both spent, and had low interest rates, it gave out. Not in the ways that perhaps people expected, but a credit bubble leading to a panic is a perfectly 19th century thing to do.
The time when politicians could spend irresponsibly and allow the Fed to clean it up is over. This doesn't mean budget cutting per se, we are going to be running deficits. The question is what we are going to be buying with those deficits. Presently we are buying a war in Iraq, happy billionaires that get tax breaks that we then pay for by borrowing the money from them. The old style panic happened because in eras of hard money , places where there was hope for vast profits created rushes, for gold for example, or silver. However, as often, they were illusory. Since there was no way to print more gold or silver, or whatever combination was hard money, the only response was to let the panic burn itself out, and then start over again. There is no way to print more oil and the things that make it.
This means that there are three responses. Let it burn. Print money and then try and recoup it later, buy for example, slashing social security benefits. Create a new form of money and recapitalize. Almost everyone realizes that the first will not work, but until there is action, it may happen any way. But the difference between the last two is simple. Do people just make do with less? Or do we create more of something else? If you count in the costs of global warming and oil depletion, we are not really producing GDP, we are robbing it from someone else who will not have oil or not have an environment. The honest thing to do is to radically change direction. But honesty is in very short supply.
Everyone is a liberal now. The question is who is going to be a smart and honest liberal, and who is going to try and pretend that there is another round of Reaganomics for us all. This is not about paper, but about what kind of society we want to become, and what kind of people we want to be.