Here's What's Happening to the Economy

I think I have it figured out, roughly.  And I'm ready to assign blame.  If my narrative is not exactly true, it is a hypothesis that appears to fit the facts.  This particular hypothesis is conspiracy-free, although I still think something is really fishy about the timing of the financial crisis, peaking as it did just when McCain started leading in the polls.  But until we see some smoking guns, no conspiracy theory from me.

(By the way, I am answering my own question of March 1, 2009 : "How Did This Happen?")

What we have is a four-tiered avalanche.

  • Tier 1.  The US housing market was a bubble that burst, which can be blamed mostly on Democratic politicians.
  • Tier 2.  That led to a global financial crisis because so many investment and insurance firms around the world traded in mortgage-backed derivatives that no one understood.  The blame for this part is complicated; more below.
  • Tier 3.  That financial crisis led to an over-reaction on the part of politicians.  The TARP legislation in the US in particular provided the double-whammy of being largely ineffective in its own right, and signaling to investors everywhere that it is time to panic.  Blame this on just about everyone in charge or wanting to be in charge:  Treasury Secretary Paulson, Fed Chairman Bernake, President Bush, both presidential candidates and both parties in Congress (but mostly Democrats).
  • Tier 4.  And that led to the political meltdown in the US, in which a socialist agenda is being implemented as quickly as possible, in the name of crisis management.  Blame this one on the Democrats and the people who vote for them.

Market Reaction

At each step, the markets gave us an estimate of the damage done.  The housing trouble was becoming apparent in early 2008, and by July 11, IndyMac, a large mortgage lender in Southern California, failed.  By August 11, the S&P 500 closed about 10% below its 2008 starting point.  The market didn't like the housing trouble, but it was not causing a full bear market.

September was a bad month.  Fannie Mae and Freddie Mac failed and were taken over by the US government.  Lehman Brothers and then AIG failed.  Other investment banks around the world were failing as well.  The housing bubble, its effects through the financial industry and even the European recession were apparent by then.  But from August 11 to September 19, the S&P fell less than 4%.  Apparently, the markets were not that upset with these large bank failures.

Then Treasury Secretary Paulson went on Meet the Press and announced an urgent need for a massive bailout.  He would put a $700B price tag on that bailout.  It became law rather quickly, by October 3.  From September 19 to Election Day, November 4, the S&P would fall another 20% - a full bear market on top of an already bearish one.  Now the markets were upset.  Thanks, Hank.

The next day, we knew who won the election: another 5% decline in the S&P in a single day.  Over the coming months, Obama would ask for the second $350B of TARP funding.  He would announce the need for a stimulus package, later passed at a price tag of $787B.  His new Treasury Secretary would say they would need another $500B to $1 trillion to rescue the banking system; they'd have to see how it goes.  Obama said he'd spend $275B to limit foreclosures.  The new Democratic House passed a $410B addition to the FY09 budget, just because they thought President Bush too stingy.  Etc.  Etc.

And then scales started coming off eyes as Obama released his FY2010 budget.  A $1.75 trillion deficit, or 12.3% of GDP, the greatest percentage since World War II, and tripling the worst President Bush ever gave us from 2001 through 2008.  Obama would not come close to projecting a balanced budget even by 2019, even giving himself rosy assumptions, ten years to figure things out, and a few years to pass the trash to his successor.

From November 4 to March 9 (as I write), the S&P would fall yet another 33%.  This was after the market had absorbed the housing bubble, the failures of multiple large banks, global recession and the Bush/Paulson TARP bailout.

Since Barack Obama won his first presidential primary, the S&P 500 has fallen 53%.

To summarize in round numbers, we can approximate the blame by time periods:

  • Housing crisis (Jan-Aug 2008): 10% market decline.
  • Financial failures (Aug-Sep): 5% decline.
  • The Paulson/Bush bailout (Sep-Nov): 20%.
  • President-elect and President Obama (Nov-Mar):  30%.

President Obama described the stock market as having "gyrations," saying it "bobs up and down day to day."  I recommend you not bob for apples with President Obama.

The Chain Reaction

There was nothing inevitable about one tier of the avalanche following the other.  We could have had a housing bubble burst without it leading to a broader financial collapse.  We could have had investment banks fail, yet still contained the damage to that segment of the market.  Even if some government intervention had been advisable, it could have been handled without the panic, theater and price tag.  And even with the huge bailouts, we could have chalked it up as a big and painful addition to our national debt, and then moved on to responsible budgeting.

But like most catastrophic failures, it took a chain reaction of mistake on top of mistake -- mostly government mistakes.

Tier 1

Tier 1 of the avalanche, the housing crisis, can be laid at the feet of Democrats almost entirely.  This is not conservative me or Rush Limbaugh talking; this is the very liberal Village Voice
.

"Andrew Cuomo, the youngest Housing and Urban Development secretary in history, made a series of decisions between 1997 and 2001 that gave birth to the country's current crisis. He took actions that -- in combination with many other factors -- helped plunge Fannie and Freddie into the subprime markets without putting in place the means to monitor their increasingly risky investments. He turned the Federal Housing Administration mortgage program into a sweetheart lender with sky-high loan ceilings and no money down, and he legalized what a federal judge has branded "kickbacks" to brokers that have fueled the sale of overpriced and unsupportable loans. Three to four million families are now facing foreclosure, and Cuomo is one of the reasons why."

Republicans tried to stop this.  Again, you don't have to take my word for it; take the New York Times word  if you prefer.

"The Bush administration is rightly pushing for the Treasury Department to regulate the two giants, along with the network of federal home loan banks. Freddie Mac and Fannie Mae provide financing to lenders by creating a secondary market for mortgages... Their current regulator is ill equipped to keep tabs on Freddie's and Fannie's sophisticated hedging strategies and the other financial moves they use to manage their huge investments."

But Democrats manned and womanned the barricades and stopped such regulation attempts.  Here was Barney Frank in 2003:

"These two entities, Fannie Mae and Freddie Mac, are not facing any kind of financial crisis.  The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing."

You can also see on YouTube how those Democrats treated the regulators.

So chalk up Tier 1 of the avalanche to Democrats.  There's not much fuzz on that one.

Tier 2

Tier 2 is not so simple. 

Financial geniuses came up with mortgage-backed securities that have all the simplicity of, say, national air traffic control.  Wired magazine has a bit of an explanation
, and I'm inclined to believe it.

At the heart of it was a sophisticated formula for estimating the value of these strange instruments.  The formula caught on like a fad within the investment community.  Even regulators believed the formula, mostly because there were no good alternatives.  And behind it all was the feeling that everything was based on houses, whose values never decline and are backed up with government guarantees anyway.

And even if you were nervous about such investments, everyone around, especially your competitors, were dealing with them and making good money.  This was a near-perfect example of an "information cascade", or herd behavior based on rational thinking.

The trouble is, some formulas don't capture reality completely and some information cascades go "down," meaning everyone is wrong even though each acted rationally.  This was such a case.

Would regulation have helped?  Maybe.  If anyone knew how to regulate these derivatives.  And if countries around the world would cooperate on something that would work.  Remember, this tier of the avalanche was global; we're talking Iceland to Latvia.  But what makes us think regulators are any smarter than the people with real money on the line?  Geniuses like Alan Greenspan were against such regulation.  (Honestly, I probably would have been also.  But I'd like to think if I had been an AIG actuary, I would have told my boss, "We're betting the company on a pig in a poke.")

Tier 2 of the avalanche can be blamed on this fad-like behavior that happens in groups of humans every so often, from Dutch tulips to wood-plank roads to, apparently, Gaussian copula functions.  The hubris of financial geniuses with thoughts of easy money didn't help either.

Tier 3

Tier 3, the TARP bailout, had a more specific cause: Henry Paulson.  Of course he was aided and abetted by everyone from Ben Bernake and George Bush to John McCain, Barack Obama and Barney Frank.  But Paulson convinced President Bush.  Paulson made the case on TV.  Paulson pressed for urgency from Congress, even at the height of a presidential election.  And Paulson came up with the figure of $700B.

Yet he never really knew how much was needed, or what it was needed for.  He talked his way into a $700B emergency slush fund, half of which would be left for his Democratic successor.  And Congress would add $150B of "sweeteners" just for grins.  Our chief earmark battler, John McCain, voted "aye" anyway.  Such was the madness of the times.

Tier 4

Tier 4 is what we are in right now: a tsunami of spending and borrowing that never ends.  Every day brings a new surprise:  $787B one day, $410B the next, and oh, maybe another $500B tomorrow - we'll see.  Foreclosure problems?  How about $275B?  Auto industry problems?  How about $25B for now and a czar?

Slam, bam, thank you ma'am, and we're halfway through implementing the Communist Party's agenda just two months into it.

And why must we do this?  It's Bush's fault.  The only way to get out of a crisis caused by Bush's $400B deficits is to spend our way to a $1,752B deficit.  That kind of thinking gets you a 60% approval rating.


And here we are

We've been spending about a trillion dollars a month since this started happening.  What do we have for it?  Lehman Brothers is still broke.  AIG, who received over $150B from the government already, is also broke.  Everybody and everything is broke.  Nothing is fixed.  And no one seems to be fixing anything.

It's as if we took our $5,000 automobile to the shop, and the mechanic charges us $1,000 per day while he "works" on it.  Yet he never fixes it.  Every time we get a look at our car, it's in pieces on the shop floor.  He tells us what a great car it's going to be in a month or so.  Trust him.  And by the way, he needs cash or a money order, not a personal check.  You already owe him $17,520.

And we think it's a great deal!  Give that mechanic shop a 60% approval rating.

Only our real problem is even worse.  It's already cost me a lot more than $17,520.

And we can't even just let him keep the car and walk away.  There is no walking away from this deal.

Randall Hoven can be contacted at randall.hoven@gmail.com or  via his web site, kulak.worldbreak.com.
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