Reacting to Daniel’s post from earlier this week. Yeah, these are valid points, especially about the mechanisms/market devices but there is something to add here, which is absent from the discussion (at least the bits I read/heard) and that is how crucially important is the overall sentiment (both public at large, policy makers and academics) for the success of the stimulus plan. Let us see, hypothetically, how such a sentiment can evolve. I agree completely with Daniel about the dominance of the archetypical ‘rational’ economic agent who will not use a tax for spending but, instead, save the additional funds. What we should be aware of is that, over the last few decades, successive generations of policy makers and economists collaborated in constructing that agent. The rise of supply-side economics along with the rolling back of the welfare state, are just two of the long-term trends that, coupled with intellectual support from leading economics departments, eroded the belief in the validity and usefulness of a Keynesian worldview. This may sound depressing as it implies that today’s public and policy makers are not just facing a dire economic situation but also have to deal with a dominant type of economic agent who is, in essence, antithetical to expansion plans. That said, there is hope here, I believe, because the same way the current ‘rational economic agent’ was put together, a different one could also come in its place – an Obama-style Homus Economicus, perhaps? 

What Obama has called the most sweeping economic package in US history (see video), was signed into law just a few hours ago.  The Act will support a reduction in taxes, investment in green technology, and ostensibly save some 3 million jobs in what have been billed as critical areas – broadband, roads, levies, mass transit, high-speed rail, education, health care modernization, smart meters in homes, increased research funding…  All of these are areas of investment designed to create productivity, and save working families and government institutions money.

What seems to be missing though is a plan for financial recovery.  Ah yes, finance is being handled by Geithner in a separate Bank Bailout (see video here). It may be true, as Obama said in the inaugural address, that economic strength is derived from ‘the makers and doers of things’. What is perhaps puzzling is that financial agents are not seen as productive – as active doers and makers of things and value – and not just as supportive of economic activity through the flow of credit.

Geithner has suggested that “the financial system is working against economic recovery”.  What if the productivity of the financial system is at the heart of economic recover?  Unfortunately, the systems of production and finance continue to remain separate objects of governance in the eyes of the state…

For the plan’s transparency, visit You can read the full 1073 page bill here. And light of Daniel’s last post on tombstones (toys that mark deals on Wall Street) check out the ‘save the date’ magnet add on the bottom of this ABC news blog.

Recession? This is not what I signed up for!

A Times article on how women whose relationships with bankers have failed comfort each other. Somewhat ironically (assymetrically?), while the initial invitation to join eschews ‘the scrutiny feminists’, the blog associated with the group (DABA) has embraced the ‘discourse on relationships and gender roles’ sparked by their exposure in the Times.

Socializing finance, indeed.

Roach on recession.

March 6, 2008


Op-ed, New York Times

Stephen Roach, chairman of Morgan Stanley Asia, thinks there’s ‘Double Bubble Trouble’ in the air.  In an op-ed today he argues that the situation in the U.S. looks a lot like Japan in the 1990’s.  Commenting on Washington’s recent manoeuvres to mitigate the onset of a recession – aggressively lowering interest rates, negotiating relief for homeowners, OFHEO’s uncapping Freddie and Fannie – he observes that:  “If the American economy were entering a standard cyclical downturn, there would be good reason to believe that a timely countercyclical stimulus like that devised by Washington would be effective. But this is not a standard cyclical downturn. It is a post-bubble recession.”  His frank assessment?  For asset-dependent, bubble-prone economies, a cyclical recovery — even when assisted by aggressive monetary and fiscal accommodation — isn’t a given.”  Gulp!

As situation diffuses everywhere and asunder, I though it might be interesting to collate a few notes, gathered from mainstream press reports, on the stages of the current global credit crisis and the impending recession…   

1. crash (2001): The popular story – after the terrorist attacks and the fall out of the bubble, risk wary investors redirect their capital into something secure and substantial – housing: ‘There’s no investment as quite as safe as houses’!  The shift is assisted by an historic FRB interest rate cuts. Based on a classic model of how monetary policy can be worked to produce macroeconomic stability, Alan Greenspan sustains liquidity in the money supply by aggressively lowering the cost of borrowing.

2. Housing bubble (2001-2005):  U.S. real estate undergoes an extraordinary acceleration leading to a ‘speculative housing frenzy’, part of a worldwide rise in real estate prices that The Economist has famously called “the biggest bubble in history”[i].  Defying sound economic expectations, the price of real estate rises “more in real terms [between 1997 and 2002] than in any previous five-year period since 1945”[ii].  The median home price surges from $177,000 in Feb 2001, to $276,000 in June 2006.[iii]  A steep increase in home equity creates more than $5 trillion in wealth a five year period, the equivalent of $70,000 per average family of four. [iv]  Through various ‘cash out’ refinancing programs and other novel home financing products, U.S. homeowners treat their houses like ATMs.  They converted inflating home equity into immediate spending money, pulling over 700 billion dollars (roughly 5% of the GDP in 2004 alone[v]) out of their homes.  Real estate’s biggest bull, David Lereah, chief economist at the National Association of Realtors NAR, boldly claims that real estate is “the only sector propping up the economy and keeping it from a full-blown free fall” [vi].

3. Housing correction (mid 2005 –ongoing): The peak of the boom is the middle of 2005.  Through the end of the year public commentary remains reassuringly optimistic but within a matter of months trading volumes in real estate have begun to slow, stagnate and then to decline.  Word of a bubble, which had previously remained within the parley of professional economists and elite commentators, spills into the public at large.  A Wikipedia entry titled ‘United States housing bubble’ appears in May.  In July, only 23% of Americans polled by Gallup are familiar with the term ‘housing bubble’, but a year later the figure has jumped to 40%.[vii]  By August, Robert Toll of Toll Brothers  – “the nation’s premier builder of McMansions”[viii] – is publicly stating that the downturn was unlike anything he’s every seen.  In Jan 2006 the buzzword is ‘soft landing’[ix] indicating a general acceptance that the market is indeed cooling, but betraying a widespread hope that things will slow without prices collapsing.  It’s the beginning of a ‘market correction’ for those, like Ben Bernanke, who prefer not to use the word ‘pop’.[x] 

4. Subprime mortgage crisis (end 2006-ongoing): At the tail end of 2006, default rates shoot up in segment of the mortgage market called the ‘subprime’ that has received little attention in main stream reporting.  The subprime is a class of borrowers with ‘blemished credit records’.  These homeowners have been “exposed to the multi-featured, exotic, exploding, non-traditional – whatever the name you have for them”[xi] mortgage products.  Alternative credit products typified by the ‘option adjustable rate mortgages’ (ARMs), are hit with bad press.  (A 2/28 ARM signifies that the payment schedule is set for two years at a low interest rate, after which payments and interest will fluctuate for the remaining twenty eight years of the loan.)  ARMs are openly condemned as “the riskiest and most complicated home loan product ever created”[xii].  During the boom however, ARMs have flourished, accounting for as much as 20% of the sizable loans volumes being underwritten in 2005 and 2006.[xiii]  The unconventional structures of ARMs prove vastly more sensitive to a slowing market and the interest rate hikes that are gradually imposed by the FRB.

5. Subprime securities crisis (2007-ongoing):  By the end of the first quarter, twenty five specialized ‘subprime mortgage lenders’ have gone into bankruptcy, announced losses, or are putting themselves up for sale because they are unable to raise sufficient cash flow from rapidly defaulting borrowers to pay their securities holders.  Regulators and the public discover that the high-risk loans issued during the buying frenzy had been packaged into bonds in the form of residential mortgage backed securities (RMBS) and pushed through to the secondary markets.  During the boom, money poured into RMBS doubling their amount to a record $476 billion.  As “a segment of the market that was once Wall Street’s darling”[xiv] falls into the proverbial doghouse, Standard & Poor’s begins massively downgrading the credit ratings on mortgage backed debt securities, an official red flag of their deteriorating quality.[xv]  Wall Street and the lending industry tightened their belts and clamped down on the underwriting of all loans classes that have fallen out of favour with investors. 

The press announces that the flight to quality “will be most severely felt by minority and poor home buyers and owners, who will face trouble refinancing adjustable rate loans that they can no longer afford”[xvi].  The U.S. Senate Committee on Banking, Housing and Urban Affairs begins hearings titled ‘Mortgage Market Turmoil: Causes and Consequences’ (March 22, 07), and consumer advocacy groups call for a moratorium on foreclosure as well as for an infusion of federal bail out funds to support payment-stressed families.  In total “[n]early 2 million ARMs are resetting to higher rates this year and next”[xvii] throwing as many households into what has elegantly been termed ‘payment shock’.  The NAR forecasts that in 2007, the U.S. will see its first drop in the median sale price since the Great Depression (April 12th, 07).[xviii]  In an attempt to stem the threat of foreclosures, treasury Secretary Henry Paulson unveils a plan that involves no federal monies, but would freeze rates for five years on some categories of exotic mortgages originated between Jan. 1, 2005, and July 31, 2007.

5. Global credit crunch (mid 2007-ongoing):  Bear Stearns discloses that the two subprime hedge funds have imploded amid the rapid decline in the market for subprime mortgages (July 16, 07).  BNP Paribas freezes three funds (Aug 9, 07).  WJS reports that the slowdown in mortgages lending had extended to other forms of U.S. consumer credit.[xix]  A general drought in the credit markets brings an end to 46 leveraged financed buyouts.[xx]  And as the Dow tumbles 387 points, the European Central Bank pumps $130 billion into the financial system, the U.S. Federal Reserve $24 billion[xxi].  In the midst of this, CDOs – structured packages of securities backed by bonds, mortgages and other loans more complex that RMBS, which have reached $503 billion, a fivefold increase in three years – hit the mainstream press.  In general, it’s not clear just where the bottom tranches, th ‘toxic waste’ of these investments are, but at least some are have worked their way into retirement and pension funds.[xxii]  The corporate ‘victims’ of the crisis start piling up:  Stan O’Neal CEO of Merrill Lynch retires (Oct 28, 07); Prince steps down as head of Citigroup (Nov. 5, 07); James Cayne of Bear Stearns resigns (Jan 7, 08).  Then come the write downs: Wachovia, $ 1.7 billion (Nov, 10, 07); BofA $3 billion, (Nov 14, 07); Morgan Stanley, $9.4 billion (Dec 20, 07); Bear Sterns, 1.9 billion (Dec 20, 07); Citigroup, $18 billion (Jan 15, 08); JP Morgan Chase 1.3 billion (Jan 16, 08).   It is estimated that Wall Street’s largest banks and brokers will be forced to write down as much as $130 billion and losses may reach $400 billion.[xxiii]    

6. Recession (Jan 2008):  Talks start to help bailout bond insurers such as Ambac Financial. The markets continue to experience high volatility and the Feds cut the federal funds rate twice, back to 3-1/4%, in a bid to stop the onset of a recession.  After a weak holiday season, U.S. consumer spending slows…[xxiv]  [To be continued.]

[ii]The Economist. ‘As safe as what?’. Aug 31, 2002 

[iii] Bob Ivry. Foreclosures May Hit 1.5 Million in U.S. Housing Bust (Update 3). Bloomberg March 12, 2007

[iv] Dean Baker. ‘The Housing Bubble Fact Sheet Issue Brief’ Center for Economic and Policy Research. July 2005 

[v] Edmund Andrews.  ‘Most Homeowners Not Overly in Debt, Fed Chief Says’ NYTimes. Sep 27 2005   

[vi] David Lereah. Why the Real Estate Boom Will Not Bust – And How You Can Profit from It, Currency Publishers. 2006

[vii] Hubert B. Herring. ‘If No One Whispered ‘Housing Bubble’, There’d Be No Worry’ NYTimes April 30, 2006

[viii] Paul Krugman. Op-Ed. NYTimes August 25, 2006

[ix] Stephanie Rosenbloom. ‘The Power of Words’ NYTimes Jan 29, 2006  
[xi] Daniel Mudd. Fannie Mae President and CEO Remarks, Delivered January 31, 2007 to Citygroup, 2007 Financial Services Conference  
[xii] Mara Der Hovanesian. ‘Cover Story: Nightmare Mortgages’ Business Week Sept 11, 2006

[xiii] Victoria Wagner. ‘A Primer for the Subprime Problem’ Business Week March 13, 2007    

[xiv] Vikas Bajaj. ‘Freddie Mac Tightens Standards’ NYTimes Feb 28, 2007  

[xv] Vikas Bajaj. ‘Rate Agencies Move Towards Downgrading Some Mortgage Bonds’ NYTimes July 11, 2007;  Bloomberg News, July 13, 2007

[xvi]  Ibid.

[xviii] James R. Hagerty. ‘Realtors Predict Price Drop, Lower Forecasts for Sales’ April 12, 2007  
[xx] Victorial Howley et al. ‘Credit Chill Freezes Leveraged  Deal’ WJS Aug 3, 2007  

[xxi]  Tomoeh Murakami Tse an David Cho. ‘Credit Crunch In U.S. Upends Global Markets’ Washington Post Aug 9, 2007  

[xxiv] Michael Barbaro and Louis Uchitelle. ‘Americans Cut Back Sharply on Spending’ NYTimes Jan 14, 2008;  Shobhana Chandra and Andy Burt ‘U.S. Recession is Now and Even Bet as Spending Slows’ Bloomberg Feb 8, 2008