It may be the one-year anniversary of an amazing stock market rally, but economists are sounding rather pessimistic these days.
A growing expectation of a double-dip recession is evident in a new poll of financial executives...the poll found more than half of financial executives predicting another downturn, and most expecting jobs recovery to lag into 2011.
The predictions don't end with just this poll. Nouriel Roubini is also warning of a second leg down, and even more disturbing is this report.
Even as many Americans still struggle to recover from the country's worst economic downturn since the Great Depression, another crisis – one that will be even worse than the current one – is looming, according to a new report from a group of leading economists, financiers, and former federal regulators.
What is important isn't the warnings themselves, it is the why that matters. The why tells the story, not just of how the crisis happened, but also what we should be doing. In this case, the why also tells us much about our economy and are values.
From the report:
The report warns that the country is now immersed in a "doomsday cycle" wherein banks use borrowed money to take massive risks in an attempt to pay big dividends to shareholders and big bonuses to management – and when the risks go wrong, the banks receive taxpayer bailouts from the government.
"Risk-taking at banks," the report cautions, "will soon be larger than ever."
The report centers on the simple fact that the financial system has not been reformed, and is in fact more concentrated than even before the crisis. It also blasts our political leaders for showing none of the backbone and good sense that is needed at a time like this.
Despite the scary quotes, the report doesn't go as far as it probably needs to go. For instance, William Black, the guy who helped clean up the S&L banks in the 90's, has this opinion on the state of the financial industry.
PAUL SOLMAN: What would you have us do about the major financial institutions as they currently exist?
WILLIAM BLACK: First, stop them from getting bigger. The 19 largest institutions are what we call systemically dangerous institutions. Many of them are already insolvent on any real market value basis.
PAUL SOLMAN: What do you mean insolvent? I mean, they're reporting large enough profits, that they can give bonuses to their employees.
WILLIAM BLACK: They were able to get Congress to extort FASB, which is the Accounting Standards Board, to change the rules, so that you no longer have to recognize losses on your bad loans, unless and until you actually sell them.
A country full of broke banks is not a new scenario. It happened as recently as the early 1990's in Japan.
Like Japan, we had a credit-induced stock market and real estate bubble. Like Japan, both bubbles burst around the same time. Like Japan, the government decided to stimulate now and reform later.
The Japanese government used targeted tax cuts and infrastructure spending, with the budget going from positive territory to deeply negative territory, much like we are today. Japan's central bank responded by cutting interest rates to zero, much like we have today.
Japan has run up the national debt equal to 200% of GDP — the greatest Keynesian stimulus program in history — all in the name of stimulating the economy back to health. It has failed miserably. Japan’s nominal GDP is about the same as when the stimulus began. Those who advocated the policy blame Japan’s failure on either the stimulus being too small or not being sustained for long enough – that is, the dosage, not the medicine itself, was at fault...
What ails Japan is a lack of reforms, not stimulus. The prolonged and massive bailout has only allowed a bad situation to continue. As governments around the world look at their own problems, this is the lesson they should draw from Japan – not the wrong one that insists Japan should have spent more.
Throwing money at a problem that is essentially created by easy money is the wrong solution. The country is suffering from decades of malinvestment created with bad debt. That bad debt needs to be washed out of the system. Losses need to be recognized and written off.
Fighting the last war
Right from the start of this crisis, our leaders have prescribed the wrong medicine for what ails us. Ben Bernanke and Timothy Geithner have approached this as a crisis of liquidity (i.e the ability to borrow) instead of one of insolvency. Renown economists such as Paul Kruman and James Galbraith have pointed out this fundamental error to no avail.
What does it mean to make this mistake? A good example of the consequences of this flawed policy are in this mostly overlooked news article.
Nevada Federal Credit Union has a deal for big savers: Withdraw your money and you'll get a bonus...
The financial institution typically uses member deposits, including certificates of deposit and money market accounts, to make loans, which typically bear higher rates than deposits.
Beal figures those interest-bearing accounts are a money-losing proposition in Nevada's current depressed economy.
"We don't have any loan demand right now," Beal said.
Approaching this as a liquidity problem means the prescription is to push down interest rates and making sure that financial institutions can borrow all the money they need from the Federal Reserve. As is evident in the example above, that policy has actually done harm instead of helped.
The problem isn't the ability of banks to get money. The problem is finding credit-worthy borrowers. Everyone from Wall Street to Main Street is already overloaded in debt after purchasing overvalued assets. This weird dynamic has broken the traditional banking model that all financial regulation is built upon.
The old definition of banks, "take demand deposits and make commercial loans," has been changed in practice to a new one: "borrow money guaranteed by the government and make real estate loans." The implications of this structural shift for systemic financial risk have yet to be worked out.
The year long stock market rally has managed to push bank equity values up and give them the appearance of health, but their underlying portfolios are still full of toxic assets that have continued to fall in price. Thus the insolvency of the banks has continued. William Black says that this is all by design.
The administration and industry do not want the public to know that the financial system brought us to the brink of a Great Depression and that Treasury and the Fed only delayed that catastrophe by adopting policies that (1) increased "moral hazard", which makes future crises more likely, and (2) combine the worst elements of "crony capitalism" and the "socialized losses."
There has been no honest examination of the crisis because it would embarrass C.E.O.s and politicians...
Instead, the Treasury and the Fed are urging us not to examine the crisis and to believe that all will soon be well. There have been no prosecutions of the chief executives of the large nonprime lenders that would expose the "epidemic" of fraudulent mortgage lending that drove the crisis. There has been no accountability.
The first step toward fixing this mess is creating accountability. The idea that it was a "few bad apples" has been floated, but no one has fallen for it.
Very quietly, Wall Street has been losing one lawsuit after another from angry investors. Wall Street has paid out $430 Billion in damages to victimized investors in 1,500 different lawsuits. Yet the SEC is unable to bring a single criminal charge against a bank chief executive.
It isn't just Black who thinks the crisis was caused by fraud. Elizabeth Warren also suspects massive fraud, as does Janet Tavakoli, Congress woman Marcy Kaptur, economistMax Wolff, and economics professorJames K. Galbraith.
You had fraud in the origination of the mortgages, fraud in the underwriting, fraud in the ratings agencies.
Instead of doing what is right, both the Bush and Obama Administrations have worked hard to eliminate accountability. If anything, there appears to be an ongoing cover-up that spans both White House administrations and both parties in Congress. The fraud even appears to stretch into the Federal Reserve itself.
The news media has participated in this sham by covering the crisis in a way that takes all the human elements out of it.
What's a little fraud between friends?
As Elizabeth Warren has pointed out repeatedly, few wealthy investors "took a haircut" from their bad investments, few CEOs lost his jobs, and no Too-Big-To-Fail bank was broken up. Nothing has changed on Wall Street, except that there are fewer banks where bankers are free to commit fraud.
Reform is important, but prosecuting the fraud is even more important. The crisis happened because no one was sure of the extent of the fraud, so everyone stopped loaning money to each other, and buying each other's financial products. There was a crisis of trust. Trust must be restored before the system starts working properly again, and to do that the criminals must be held accountable.
The public will need to "hold the perpetrators of the economic disaster responsible and take what actions they can to prevent them from harming the economy again." In addition, the public will have to see proof that government and business leaders can behave responsibly before they will trust them again, he argued.
There was a three year gap between the 1929 stock market crash and the Pecora Commission, which exposed to the public massive fraud and conflicts of interest that caused the crash. During that three year period the country sank into Depression. The results of the Pecora findings was the Glass-Steagall Banking Act of 1933, the Securities Act of 1933, and the creation of the SEC.
The economy would never have recovered without these reforms, the reforms would never have happened without the Pecora Commission, and the Pecora Commission would never have been created without a collective decision that people had to be held accountable for the fraud.
Until the collective outrage of the American citizens overwhelms the politician's loyalty to their corporate sponsors, and some of these criminals are prosecuted, then we will continue to follow the path of Japan. One year of sluggish growth and high unemployment will follow the next, while the government runs up enormous deficits in the false hope that the next stimulus bill will finally do the trick.
This is one of the instances where the moral and just thing also happens to be the smart thing to do. The criminals must be exposed and punished. The speculators on Wall Street must recognize their losses. The financial monopolists must be broken up.
It seems so simple. What lies between us and this logical outcome is a broken political system and a wealthy criminal class.