Tuesday, September 15, 2009

Alulu Brother Kevin

"We will not go back to the days of reckless behavior and unchecked excess."
- President Barack Obama, speaking on "Financial Rescue and Reform" at Federal Hall in New York City, Sep. 14, 2009

"That's it; my days of reckless behavior and unchecked excess are over."
- Kevin Depew, speaking early in the morning to no one in particular on hundreds of separate occasions.

By Kevin Depew
via Minyanville

Not many Americans know this, but Wall Street is actually just a dead-end corridor of 1,500 feet carved like a small notch into the side of lower Manhattan. One end is capped by the East River, the other by Trinity Church. The dark, narrow length between is crowded by tall, stone buildings that send down shadows of such fierce certitude that you're sure no ray of sunlight has ever once dared to intrude; like some kind of fiscal Stonehenge.

It's possible to escape these shadows by no fewer than half a dozen side streets and alley openings, but there's no shaking the creeping uneasiness that something you can't quite comprehend is taking place all around you.

Of course, what passes for escape is nothing more than silent complicity. True deliverance from Wall Street comes only two ways -- the river or the church.

It's just past noon on a crystalline Monday in New York City, and even as he's standing inside Federal Hall on Wall Street and Nassau, nearer the church than the river, it's not quite clear President Barack Obama grasps this crucial point. The occasion is to mark the one-year anniversary of The Crisis, an ill-defined, loose-fitting moment that no one, not even the president, seems to be able to pin down.

The Wall Street Journal this morning neatly packaged everything into one box: The Crisis, a Year Later. Similarly, the New York Times is running with Financial Crisis: One Year Later. The Washington Post is Taking Stock.

And yet, paging through all these stories -- digital pile after digital pile of them -- it's still unclear what The Crisis means. No one even knows what tense to use when writing about it because no one is really sure if it's over, let alone when it started. As a result, we've resorted to creating a number of extraordinary myths to help explain to ourselves what has happened.

Before we get to The Anniversary itself, let's figure out what is The Crisis? Is it Lehman's collapse? Is it toxic mortgages? Is it housing? Is it lending? Is it credit? Is it debt? Is it regulation? Is it consumption? Is it financial engineering? The answer is, yes. It's all of those things.

And so this anniversary is really no anniversary at all; we're commemorating the wrong thing. In fact, the anniversary of The Crisis is one of the myths we've created to help explain to ourselves what it is that's happened -- ironically, while we go about doing more of the very things that caused it to happen in the first place.

This is not to say that the collapse of Lehman Brothers wasn't a significant event. It was. But it was a culminating crash of a wave that had been building for years, which brings us to one of the more widely perpetuated myths from no less of a source than the chairman of the Federal Reserve.

In a speech delivered before the London School of Economics last January, Federal Reserve Chairman Ben Bernanke outlined a subtly more in-depth and critical view of the origins of The Crisis than anything he had publicly stated previously.

According to Bernanke, although the subprime debacle triggered the crisis, the developments in the US mortgage market "were only one aspect of a much larger and more encompassing credit boom whose impact transcended the mortgage market to affect many other forms of credit." Indeed.

This view further explicates and builds on the one he first stated before the Economic Club of New York in October 2007. At that time, Bernanke, like many public finance officials, had just spent months and months prior to October 2007 describing the financial crisis as "well contained" to subprime lending; an isolated outlier of what, at that time, were routinely accepted as perfectly normal credit market conditions. Of course, by January of this year, Bernanke recognized it was far deeper than that.

In January, Bernanke admitted that the negative aspects of this "more encompassing credit boom" involved "widespread declines in underwriting standards, breakdowns in lending oversight by investors and rating agencies, increased reliance on complex and opaque credit instruments that proved fragile under stress, and unusually low compensation for risk-taking."

Naturally, Bernanke didn't take the next step and acknowledge that the Fed itself was a co-conspirator in the credit orgy, but at least he did back away from the earlier assertion that everything somehow hinged on subprime lending.

The reality is that subprime lending was the inevitable consequence of The Crisis, not the cause of it. (Poor always crack first. -AM)

Housing is just a manifestation of the long-running credit boom. It's the largest piece, true, but still, it is just one piece.

As the shadow inventory of houses -- those off the market as lenders who have foreclosed on them figure out how to proceed -- becomes apparent, the magnitude of this crisis as a debt crisis rather than a housing bubble will become more apparent.

When looking at household savings along with debt-to-income levels and debt-servicing ratios, things are actually a little more worrisome today than iduring the Great Depression. Unlike the Great Depression, when insolvency was largely concentrated among farming families and mortgages (which made up a very high percentage of the population), insolvency today is not only deeper and more pervasive, but far more difficult to engage from a policy standpoint precisely because of a lack of concentration in any one industry.

I suspect we will be able to look back in hindsight and view this present debtor insolvency (and oversupply of houses) in terms of a massive degree of over-consumption that was difficult to evaluate because we were actually living in it; a bit like trying to see the back of your head while staring into a mirror.

(Pay the man Shirley.-AM)

According to this myth, bailing out the financial system was a matter of practicality. Despite the fact that there are six billion people in the world, somehow we've come to believe that the tiny fraction who work in banking have made it impossible to live without them. Would it be difficult? For a few months, probably. But impossible? That's ridiculous on its face.

The globalization of finance and supposed diversification of the global financial and risk management industry was an appealing element of the credit boom. But today the apparent complexity of the financial system is used as a reason to prop up otherwise failed institutions.

You can build a hamburger with one ingredient -- ground beef -- or you can use 100, but in the end it is still just a hamburger. Our credit system has hundreds of ingredients these days, but it's still just a hamburger... one that's been doctored up with all of these fancy ingredients.

Think about it this way. The word credit comes from the Latin "credere," which means, literally, "to believe, or to trust." That is really all you need to know about the modern financial system. When the credere is gone, the whole thing unravels, and it works both ways, from lender to borrower, and from borrower to lender. This is why monetary and fiscal policies aren't working.

Credit is nothing but a belief. That belief, credere -- stretched to its limits by the policies of endless credit expansion -- was weakened to such an extent that it's developed what may be likened to an autoimmune disorder, a condition where the immune system mistakenly attacks itself, destroying even healthy body tissue in the process.

Under normal circumstances, without excessive credit expansion policies, the system's immunity defenses would attack and destroy the toxic substances -- such as subprime mortgages -- and leave the healthy tissue alone. However, the system now has turned on itself and is attacking healthy body tissues and toxins because it can no longer distinguish between the two.

Unfortunately, autoimmune disorders often results in the destruction of the body itself (the financial system), or abnormal growth of an organ (government and regulation) and/or changes in an organ's function (the banking system).

Finally, the most dangerous myth of all; that The Crisis itself has passed.

On one hand, government has the right to take credit for "the economic recovery;" it's totally responsible for it. I mean that. One hundred percent of global economic activity is due solely to fiscal stimulus. And according to Gluskin Sheff's David Rosenberg, an estimated 80% of world gross domestic product growth is due to government contribution.

Unfortunately, government intervention and support of credit markets has, to a large degree, been successful. Credit spreads have narrowed in unprecedented fashion from a year ago as credit buyers have fallen all over each other to buy corporate and government debt. Wait, what do I mean by unfortunately? Well, unfortunately, we're rapidly moving right back to the same place we were before the real issues facing us in The Crisis became apparent. In other words, all that has happened is that the doctor (the government) has been successful in treating the symptoms of the disease (failed institutions and widespread insolvency), but in doing so the disease itself (too much debt) has actually worsened.

Inevitably, there will come a point when the symptoms of the disease stop responding to treatment. About the Great Depression, someone once said, "Just when we thought it was over, it was really only beginning."

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