Answer: A few months ago.
How do I know?
Let's look at the evidence.
1. Mere recessions are generally triggered by pricing shocks; depressions by the collapse of a credit bubble.
2. Mere recessions do not require the effective nationalization of the pillars of global finance.
3. The national housing industry has been in a full-fledged depression for more than two years now without any evidence it has reached bottom.
4. The usual market mechanisms for liquidating insolvencies are not operational.
Much is made of comparisons to various post-Great Depression downturns as guidance to the likely path of this current crisis. Most recent recessions have resulted from transitional shocks; anti-inflation monetary policy shifts in the 1950's, the oil price shocks of the 1970's, the interest rate squeeze on inflation leading to the "Carter/Volcker/Reagan Recession" of the early 1980's, the dot-com bubble bursting at the beginning of this decade. By definition, each of these recessions included a period of "negative growth" in the GDP and some degree of increased unemployment.
Statistically, we are well into another period of negative growth in our GDP and rising unemployment. Beyond this statistical similarity, the nomenclature of "recession" obscures a more profound difference. Like the Great Depression -- and unlike all of the interim recessions -- our current crisis is the result of a credit bubble bursting, characterized by a profound and pervasive insolvency throughout the international credit markets.
The scope of this systemic insolvency is breathtaking.
The United States alone has extended credit, loan guarantees, and cash infusions exceeding $1 trillion in an effort to head off the serial collapse of the world's largest financial institutions. While serial collapse has been forestalled for now, the scope of insolvency actually appears to be growing.
The pillars of US finance are generally not lending to one another except where compelled by the feds to do so.
Common sense suggests we are somewhere towards the beginning of a multi-year period of "negative growth" with no identifiable basis for recovery now in sight.
Consider the amount of time necessary to actually deleverage illiquid, loss mounting assets when there is no market for them. Unless these assets can be sold off to government, many will be held to maturity and swaps to cover risk of default will last as long. How can anyone determine the solvency of a financial institution under these circumstances? Under these circumstances, how can anyone imagine the private sector and traditional market forces can resolve this crisis?
Thursday, November 27, 2008
Tuesday, November 25, 2008
The News Gets Worse
I'm lying in bed with a temperature of 102' reading the business press on Citi II, the second unprecedented bailout of Citigroup in less than six weeks.
The federal government has now committed nearly $350 billion to Citigroup alone in direct capital infusions and guarantees on Citi's "toxic" and potentially toxic mortgage-backed securities portfolio. This is bad news - - despite the rosy reaction of stock markets around the world.
First, it is now obvious the Bush Adminsitration's ever-evolving "TARP" program was never up to the task. The federal government found it necessary to guarantee over $300 billion in Citigroup debt-backed assets to make Citigroup sufficiently credit-worthy to borrow from other banks -- its only hope of remaining a going concern as an international bank. As the other major banks line up to strike similar deals - - and they must - - the TARP's original claim that there were $700 billion in toxic assets out there will be revealed for the arbitrary and naive number it was.
Nor is Citigroup yet out of the woods. These capital infusions and guarantees are only meant to create some kind of floor under it's mortgage-backed securities exposure and provide the liquidity to make Citigroup a less risky borrower on the world's capital markets. Citigroup's other questionable loan portfolios - - particularly its credit card, commercial real estate, and other securitized debt - - will continue to sour as economic activity slackens.
The federal government is struggling on a daily basis to restore lender confidence and liquidity within the international capital markets. It has tried guaranteeing commercial paper, money market fund deposits, expanded FDIC deposits, interbank loans, and now finds it must place a floor under the mortgage-backed securities exposure of major banks. The evidence suggests the core purpose of federal government intervention is to do whatever is necessary to avoid another Lehman-sized bank failure. That's a reasonable goal, but we need to recognize it for what it is -- an ad hoc reaction to impending disasters as they arise.
However reasonable a goal in the near-term, the decision to forestall free market restructuring of these financial institutions has serious potential long-term implications. In other words, twice in the past six weeks Citigroup has reached insolvency - - its liabilities exceed its assets. The entire financial sector recognizes this and, understandably, won't lend to an insolvent bank or buy its short-term debt. Twice in the past six weeks the federal givernment has stepped in to pad the asset column with capital infusions exceeding $50 billion.
This time, the federal government has also guaranteed 90% of potential losses on over $300 billion of these assets at Citigroup, but they remain on Citigroup's books. It will take decades for many of these assets to be retired and Citigroup will have to retain reserves against these possible losses during that period -- money that might otherwise provide liquidity to the economy through business and personal loans. Repeat that same story among the other major banks and you can see how much dead weight in potentially bad loans will hang over the financial sector for years to come. There are no private buyers for these assets at this time at any price. Even the federal government backed off buying these assets from the banks after TARP was passed -- choosing less costly guarantees instead.
Normally - - and for smaller banks and businesses facing insolvency - - the liability side of the ledger is reduced through restructuring (selling off assets to pay down liabilities and focusing on a core business to generate sufficient cash to pay down the rest over time) or bankruptcy. The federal government has taken bankruptcy off the table for the likes of Citigroup. Without the fear of bankruptcy, the impetus to restructure is less urgent. In fact, the political will to tackle the extreme dislocations which may occur when the behemoths of the financial world all face insolvency simultaneously, and so must restructure simultaneously, can disappear. Faced with a choice between certain pain now and perhaps less pain extended into the distant future, most politicians will choose the latter. This is what happened in Japan, resulting in their infamous "lost decade," humbling an economic powerhouse thought to be more saavy and politically disciplined than the United States during its meteoric rise in the 1980's.
This is the real danger of these successive bailouts. We are watching the transfer of decision-making authority from the collective rough and tumble of the free markets to the White House. We know free markets can be brutal things and Citigroup filing for bankruptcy would likely shake financial markets to their core. We also know no White House will be able to resist the political pressure of major contributors for long - - allowing businesses which should have failed in a free market to drag on.
In sum, a pattern is emerging which strongly suggests the federal government will continue to prop up the biggest firms, encourage restructuring through mergers where solvent buyers can be found, and pour money into the capital markets in the hope greater liquidity and inflation eventually create a market for the toxic assets weighing down the big firms' balance sheets. The pattern strongly suggests we are reducing pain in the near-term, but extending it over time. Where "economists" a year ago questioned whether we would even see a recession, they now speak confidently about a recession lasting several quarters to a year. A year from now, they will be talking about an extended period of low- to no-growth stretching into the next decade. Five years from now, they'll be criticizing the powers that be today for showing too little resolve, propping up firms they should have allowed to fail.
The federal government has now committed nearly $350 billion to Citigroup alone in direct capital infusions and guarantees on Citi's "toxic" and potentially toxic mortgage-backed securities portfolio. This is bad news - - despite the rosy reaction of stock markets around the world.
First, it is now obvious the Bush Adminsitration's ever-evolving "TARP" program was never up to the task. The federal government found it necessary to guarantee over $300 billion in Citigroup debt-backed assets to make Citigroup sufficiently credit-worthy to borrow from other banks -- its only hope of remaining a going concern as an international bank. As the other major banks line up to strike similar deals - - and they must - - the TARP's original claim that there were $700 billion in toxic assets out there will be revealed for the arbitrary and naive number it was.
Nor is Citigroup yet out of the woods. These capital infusions and guarantees are only meant to create some kind of floor under it's mortgage-backed securities exposure and provide the liquidity to make Citigroup a less risky borrower on the world's capital markets. Citigroup's other questionable loan portfolios - - particularly its credit card, commercial real estate, and other securitized debt - - will continue to sour as economic activity slackens.
The federal government is struggling on a daily basis to restore lender confidence and liquidity within the international capital markets. It has tried guaranteeing commercial paper, money market fund deposits, expanded FDIC deposits, interbank loans, and now finds it must place a floor under the mortgage-backed securities exposure of major banks. The evidence suggests the core purpose of federal government intervention is to do whatever is necessary to avoid another Lehman-sized bank failure. That's a reasonable goal, but we need to recognize it for what it is -- an ad hoc reaction to impending disasters as they arise.
However reasonable a goal in the near-term, the decision to forestall free market restructuring of these financial institutions has serious potential long-term implications. In other words, twice in the past six weeks Citigroup has reached insolvency - - its liabilities exceed its assets. The entire financial sector recognizes this and, understandably, won't lend to an insolvent bank or buy its short-term debt. Twice in the past six weeks the federal givernment has stepped in to pad the asset column with capital infusions exceeding $50 billion.
This time, the federal government has also guaranteed 90% of potential losses on over $300 billion of these assets at Citigroup, but they remain on Citigroup's books. It will take decades for many of these assets to be retired and Citigroup will have to retain reserves against these possible losses during that period -- money that might otherwise provide liquidity to the economy through business and personal loans. Repeat that same story among the other major banks and you can see how much dead weight in potentially bad loans will hang over the financial sector for years to come. There are no private buyers for these assets at this time at any price. Even the federal government backed off buying these assets from the banks after TARP was passed -- choosing less costly guarantees instead.
Normally - - and for smaller banks and businesses facing insolvency - - the liability side of the ledger is reduced through restructuring (selling off assets to pay down liabilities and focusing on a core business to generate sufficient cash to pay down the rest over time) or bankruptcy. The federal government has taken bankruptcy off the table for the likes of Citigroup. Without the fear of bankruptcy, the impetus to restructure is less urgent. In fact, the political will to tackle the extreme dislocations which may occur when the behemoths of the financial world all face insolvency simultaneously, and so must restructure simultaneously, can disappear. Faced with a choice between certain pain now and perhaps less pain extended into the distant future, most politicians will choose the latter. This is what happened in Japan, resulting in their infamous "lost decade," humbling an economic powerhouse thought to be more saavy and politically disciplined than the United States during its meteoric rise in the 1980's.
This is the real danger of these successive bailouts. We are watching the transfer of decision-making authority from the collective rough and tumble of the free markets to the White House. We know free markets can be brutal things and Citigroup filing for bankruptcy would likely shake financial markets to their core. We also know no White House will be able to resist the political pressure of major contributors for long - - allowing businesses which should have failed in a free market to drag on.
In sum, a pattern is emerging which strongly suggests the federal government will continue to prop up the biggest firms, encourage restructuring through mergers where solvent buyers can be found, and pour money into the capital markets in the hope greater liquidity and inflation eventually create a market for the toxic assets weighing down the big firms' balance sheets. The pattern strongly suggests we are reducing pain in the near-term, but extending it over time. Where "economists" a year ago questioned whether we would even see a recession, they now speak confidently about a recession lasting several quarters to a year. A year from now, they will be talking about an extended period of low- to no-growth stretching into the next decade. Five years from now, they'll be criticizing the powers that be today for showing too little resolve, propping up firms they should have allowed to fail.
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