JUDGMENT CALLS
Robert J. Samuelson
The Engine of Mayhem
There are dangers in deleveraging too fast.
It's easy to explain the continuing financial chaos—and the failure of governments to control it —as the triumph of psychology. Fear reigns, and panic follows. Everyone dumps stocks because everyone believes that everyone else will sell. Only rapidly falling prices attract sufficient buyers. All this is true. But it ignores the real engine of mayhem: "deleveraging." That's economic shorthand for purging the financial system of too much debt.
Just how this deleveraging proceeds will largely determine the fate, for good or ill, of the crisis. The turmoil has already moved beyond "subprime mortgages," which (it now seems) merely exposed widespread financial failings. These were global, not just American, and their pervasiveness explains why leaders of the major economies have struggled, so far unsuccessfully, to fashion a common response.
Alone, American subprime mortgages should not have triggered a global crisis. Losses are smaller than they seem. Mark Zandi of Moody's Economy.com estimates that all U.S. mortgage losses will ultimately reach $650 billion. But that hefty amount pales against the value of all financial assets—stocks, bonds, bank loans. For the United States, these totaled almost $60 trillion at the end of 2007; for the world, the comparable figure exceeded $250 trillion.
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Such a vast financial system should have absorbed the subprime losses without calamity. By way of contrast, the stock market's drop since its peak in October 2007 to Friday was $8.4 trillion, or 42 percent, reports Wilshire Associates. The official response to the subprime losses also seems larger than the problem. The government has taken over mortgage giants Fannie Mae and Freddie Mac; the Federal Reserve is pumping out short-term loans of $1 trillion or more; and Congress's $700 billion rescue allows the Treasury Department to buy subprime securities and to make direct investments in banks.
Still, the situation has not stabilized; the crisis continues. It's as if more firefighters had arrived at a burning home and turned their hoses on the flames, but the conflagration raged anyway. What's going on?
What we've discovered is that the real problem is bigger. Large parts of the financial system are too thinly capitalized and too dependent on unreliable short-term debt. Leverage ratios often reached 30 to 1 for investment banks and hedge funds (that is, $30 of debt for every $1 of capital). The presumption was that the MBA types had learned how to "manage risk." That false conceit backfired. Low capital didn't adequately protect against losses. Confidence and trust evaporated, because no one knew which institutions held suspect securities, how much the losses were and who was ultimately safe.
Deleveraging—a shift from excessive debt toward more capital—is inevitable and desirable in the long run. The trouble is that, in the short run, it could destabilize the economy if it proceeds too rapidly.
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Member Comments
Posted By: Nowforthetruth @ 10/14/2008 9:13:17 PM
Comment: "Press Releases
AJC Strongly Condemns Rev. Jesse Jackson's Comment on American Jews
October 14, 2008 - New York - The American Jewish Committee (AJC) has condemned the Rev. Jesse Jackson's statement about 'Zionists who have controlled American policy for decades.'
"Rev. Jackson's remarks, which appeared in an interview with the journalist Amir Taheri in today's New York Post, echo classic anti-Semitic conspiracy theories about Jewish power," said AJC Executive Director David A. Harris. 'This statement, regrettably, is not the first troubling comment by Rev. Jackson regarding Israel, Zionism and the Jewish people.'
Arguing as a private citizen that an Obama administration could bring significant change to U.S. foreign policy, Jackson was quoted as saying that "Zionists who have controlled American policy for decades" would lose much of their influence should Senator Obama be elected president."
http://www.ajc.org/site/apps/nlnet/content2.aspx?c=ijITI2PHKoG&b=849241&ct=6107743
And people are upset about raciest comments some in the crowd are allegedly saying at Palin events? Isn???t this the same Democrat leader who once called New York "Hymietown"?
Posted By: junkmail6 @ 10/14/2008 3:39:49 PM
Comment: Both parties in Congress and the administration had a hand in covering up the impending collapse, and nobody wanted anything different. I'm sick of the finger pointing; it's time to look at what happened and realize that some of our (my) most precious assumptions don't work anymore. Free markets only work when companies can collapse without sucking everyone else down with them. I could care less about Wall St., and the Dow Jones will recover in a year or two. But the fact that my job is at risk, even though what I do has *nothing* to do with mortgages hedge funds... That gets my attention.
If we can't afford to let companies fail, then we can't afford to let them do as they please, especially when the CEO's are motivated to build a bubble, get out, and let their companies fail right after they sell off their options. I can't believe I'm saying this, but it is time for some *serious* regulation, including *serious* restrictions on executive compensation. How about all their bonuses stay in an escrow account for 5-10 years after they leave? Not to mention *tight* regulation on debt to asset ratio's for *all* financial companies.
Do I sound a little *frustrated*?
Posted By: Adrian Zolkover @ 10/14/2008 2:46:01 PM
Comment: This administration and its Republican majority in Congress, including Senator McCain, over most of the last 8 years, have deliberately created this problem. It's no suprise. The U.S. Comptroller of the Currency, Administrator of National Banks publishes a report 4 times a year showing, for example, that J.P. Morgan Chase Bank NA has total derivatives of $89,997,271 TRILLION, which gives them a total credit exposure to capital ratio of 411.6 times (not 411.6%). I have read the estimated wealth of every economy in the world added together is around $97 trillion. Bank of America and Citibank National ASSN each have over $35 trillion of derivatives and credit exposure to capital ratios each of over 200 times. This didn't happen overnight. This information can be found on the report they publish, "OCC's Quarterly Report on Bank Trading and Derivatives Activities First Quarter 2008. Table 4." For years, economic experts and others such as Warren Buffet have repeatedly warned this administration of the dangers of not regulating the banks to prevent this from happening. They continually refused to regulate. In my mind, a main danger here, is that money such as drug lord's, fascist vast profits from wars politically motivated and mismanaged, and the very people who managed these banks and made billions of dollars, will again clean up by purchasing for pennies on the dollar, as we are the victims of the mess they deliberately created. I think it is most wise to keep in mind author Samuelson's warnings about too much deleveraging of debt too fast. This could be most difficult to control. I think controlling marginal changes, like one quick step after another, would be safer. Kind of like preventing the ship from being attacked, and the pirates with their life rafts looting all the gold, as everyone else is scrambling for safety.