The people in charge aren’t saying that this is the worst financial crisis since the great depression. They prefer “since WWII”. I don’t like to write about depressing news because not many people like to read about it, but this is fascinating and terrifying at the same time. I’m just glad I can write about this now without sounding like a permabear.
For some reason, when I read news articles weird analogous cartoons appear in my head. In this case I’m picturing a bunch of crusty old bankers, crammed into a shopping cart, headed down a perfectly smooth slope, picking up speed. The average person on the street knows we’re in a recession. But if you watch Bloomberg (live feed – much better than CNBC but not as good as some blogs) and read the best finance blogs you know that what is happening right now is basically a 100 year financial storm. It’s really really bad.
Why doesn’t the guy on the street know what’s going on? Because if Ben Bernanke said what some know there would be panic. Bernanke keeps referring to this as a sub prime problem. That’s not the whole story. These loans are going bad because of one simple reason: Home prices were too high. Homes bought with subprime loans were too expensive and homes bought with prime loans were too expensive. The loans were a means to an over priced end. Bernanke is shooting the messenger because the messenger is expendable. Now he’s just about out of messengers to shoot and things are still falling apart. His credibility is the only thing holding things together at this point which might explain why people are applauding during his live speech in DC right now. It’s a bit like a laugh track.
My take is that this housing correction, by itself, would cause a pretty nasty recession. But we’re adding on super leveraged derivatives, unregulated hedge funds, over extended consumers, inflation, and the death of dollar hegemony as BRIC emerges and competes for jobs and resources. My tech brain tells me that IT automation(onshore outsourcing) is probably a bigger concern for balanced wage growth than China or India.
In other words, housing is the trigger that’s allowing all of these other painful inevitabilities to unravel at the same time. Housing never would have been allowed to get so out of hand by the Fed if they weren’t trying to delay the inevitable. A look at the home price to income/rent ratios back in ’04 was enough to know that we were in a classic bubble and the Fed had to know this. The fact that they did nothing lends credence to the notion that they were aware of the systemic problems now rearing their heads.
My guess is that rates go to zero and the Fed loses a tool to “stimulate” the economy. Odds of a 1% rate cut are at 50% right now so we’re not far off from ZIRP (zero interest rate policy). Japan ran into the same problem almost 20 years ago and couldn’t stop deflation.
So the only question remaining, assuming things continue to deteriorate (which looks likely): Will US ZIRP lead to inflation or deflation? If we see deflation the Austrians win. From Mises’ Human Action:
There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved. (p. 572)
Mises was probably a bigger contributor to the Austrian School than Hayek but he never won a Nobel Prize.
Photo by DarthLen