Bad Medicine
There is a terrific opinion piece in the Sunday Washington Post, titled Bad Medicine that is your MSM Saturday morning reading for the day.
Its by James Grant, purveyor of the Grant's Interest Rate Observer.
While some folks (myself and Nouriel Roubini and Jimmie Rogers and Mark Faber) have been warning about Housing and Credit for two or three years, Grant has been warning that this crack up was the inevitable result of Greenspan's easy money policies for at least decade.
Here's his take:
"Low interest rates, easy money and malleable accounting rules are what plunged Wall Street into crisis. Yet it is low interest rates, easy money and malleable accounting rules that top the list of federal fixes. The unifying theme of the new bailout bill, all 451 pages of it, is the hair of the dog that bit you.
The unblinkable fact is that Americans own too much house. We overpaid and overborrowed, and many of us are "upside down," as the car dealers say. What to do? Recognize the losses and write them off. What not to do? Inflate the currency and debase accounting standards.
But inflation and debasement are the very policies being put in place. The Federal Reserve, not waiting for Congress, embarked last month on a radical program of money-printing. Reserve Bank credit -- the raw material of bank lending -- is growing at the year-over-year rate of 61 percent.
Credit creation is the Fed's signature crisis-management policy: Let a bubble inflate, then watch it burst; clean up with lots of dollar bills. After the stock market broke in 2000, then-Fed Chairman Alan Greenspan set about easing policy. In company with Fed Governor Ben S. Bernanke, the man who wound up succeeding him, Greenspan warned against "deflation." He vowed that this country would not sleepwalk through a decade of falling prices, as Japan had done. Rather, the Fed would push interest rates low enough to jolt the U.S. economy back into prosperity."
I'll bet being right is small consolation for him . . .
(Note: The cartoon above is from Grant's site, and you can order a framed version by clicking here).
>
Source:
Bad Medicine
James Grant
Washington Post, October 5, 2008; Page B07
http://www.washingtonpost.com/wp-dyn/content/article/2008/10/03/AR2008100303309.html
Saturday, October 04, 2008 | 08:58 AM | Permalink
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Jim Grant as long been one of the very best.
Easily accessible and Erudite, with an Excellent grasp of the proper Fundamentals, that the Lynch Mob (Peter & Merrill) are 100x, at least, more well-known then He, tells all the tale...
Posted by: Mark E Hoffer | Oct 4, 2008 9:32:06 AM
But this is the free markets fault. We need the government to solve it all. That's what the Fed and congress are doing.
Posted by: Dave | Oct 4, 2008 9:34:52 AM
it's called a PONZI SCHEME...
Posted by: Kid Dynamite | Oct 4, 2008 9:35:24 AM
As great as this piece is, I bet he softened it to get it printed in MSM...as for Bush, he not only hinted that there would be disater if the bill was not passed, he said it would lead to "panic."
Add Jim to the dream team panel:
Roubini, Bogle, Shiller, Volcker, Stiglitz, Grant
Posted by: Steve Barry | Oct 4, 2008 9:37:16 AM
Greenspan was correct to lower interest rates. His failure was his libertarian views towards regulation. Had banks (and housing finance) been properly regulated, the lower interest rates would have resulted in more productive investments. You will recall that the economy was on the ropes for a good 2 years after 9/11. [Editor: The Recession ended November 2001] Had the highly-leveraged mortgage security fiasco been avoided through reasonable regulation, the economy would have recovered at a much slower pace, even with the 1% fed funds rate.
We are once again in a deflationary spiral and we are most likely entering into a cascading depression. Hopefully the global central banks will implement a coordinated rate cut ASAP.
The consequences of not doing so will be double digit unemployment, massive contraction of the economy and decades before we regain any semblance of our current standards of living.
If rates are not cut, prices will deflate and the economy will contract and the response will be no doubt to cut rates at that time. Unfortunately by then the dollar will be toast, confidence in US Treasuries will have evaporated, tens of millions will be out of work, foreclosures will be even higher, home values will decline even more, the banking system will collapse and creative-destruction will morph into permanent economic destruction just as it did in the 30s.
Any risk of future inflation pales in comparison to the current risks of total economic failure. How can anyone seriously contemplate hyperinflation when asset values are falling precipitously and the credit markets are frozen?
Either we lower interest rates and take every action that can be thought of to save the economy, or we might just as well hand the keys over to China today.
~~~
[BR: There is lowering rates -- the called for prescription during a recession -- and taking rates down to 1% and leaving them there for over a year.
No economy "requires" permanent 1% Fed funds to thrive. It was one of many Greenspan failures . . .
Posted by: bsneath | Oct 4, 2008 9:56:28 AM
The Fed fight now is not simply to stop or slow a developing recession - the fight now is against a deflationary recession that has begun. (See Japan for details). Perhaps Bernanke can explain his game plan to fight deflation:
"....But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost....We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."
Bernanke, Ben S.
November 21, 2002
There are two problems with this method of re-flating - created monies cannot be directed to specific falling assets, and borrowing cannot be forced on the risk averse.
Still, the Bernanke Bailout has been underway for some time. Consider that:
More than 50% of the balance sheet of the Federal Reserve Bank is MBS and other junk.
The Fed has already been monetizing for over a month with no success. Financial Sense Online points out: "The Fed had $905.7 billion in assets as of September 3rd. In less than four weeks the Fed has expanded its balance sheet to the tune of $308.2 billion dollars, or an increase of 34% in less than a month."
The thing Mr. Bernanke and other monetarists misunderstand about deflation is that there is a change of perception among borrowers - regardless of how much money is made a-v-a-i-l-a-b-l-e, it requires risk-taking behavior to loan and borrow - and both lenders and borrowers are adverse to that risk.
Posted by: Winston Munn | Oct 4, 2008 10:09:37 AM
Once again: Thank You Ayn Greenspan
Posted by: censeo | Oct 4, 2008 10:18:24 AM
I have not read the entire bailout bill - now law, but my understanding is that it is essentially the original Paulson plan of using taxpayer money to buy bad debt at inflated prices. Just add some silly earmarks (read: pork), and some scare tactics from the Treas./Fed/Exec. branch, and voila. Now law. Treas/Fed have more power, Americans have less. God help us.
It seems to me that if Citi (C), and Wells Fargo (WFC) are fighting over the bones of Wachovia (WB), then how is the (Paulson) bailout a good thing for the taxpayer. Answer: It is not.
My understanding is that the SEC/FASB got their way and threw out "fair-value" accounting rules (read: mark-to-mkt.) as well. It appears that NO ONE is taking responsibility for this mess. Where are we setting an example of having consequences for bad decisions? Ans.: We're not. Nothing done to address the real problem of the "Shadow Banking/Finance System".
I fail to see how the Fed has lived up to their charter - since inception. The SEC has failed miserably, as well. Are financial markets more stable? Is the USD a strong currency? IS the US economy strong, and growing? Are we a creditor nation, or a debtor nation? The Fed is not just a useless appendage, but is actually an active force in destroying the wealth, and economy of the US. In wartime, that is precisely the tactic to force the defeat of your adversary. We should be more concerned about the Fed than Al Queda. the Fed should be abolished. Too late?
BTW, how does approx. $1T (round numbers) in bailouts fix even 1% losses in the $600T (BIS figures) global derivatives market (CDS, etc.). Ans.: It doesn't. We're toast.
Posted by: concerned citizen | Oct 4, 2008 10:25:13 AM
Honestly, can Bernanke, Paulson and Co. be THAT stupid??? I think the smart answer is NO! This is less a result of "bad medicine" and more of a result of 1st degree murder--these bastards are intentionally killing us! I'm just trying to figure out when the police are finally going to show up and start hauling people off to jail....
(Peter Schiff should be added to your short list of folks who raised some red flags.)
Posted by: Brian | Oct 4, 2008 10:25:37 AM
Jim Grant is completely correct about too much house, also too much SUV, too much boat and too much plastic crap in the garage.
Right on cue we note that the housing downturn has finally reached the island itself:
http://www.nakedcapitalism.com/2008/10/quelle-surprise-manhattan-real-estate.html
I agree completely with the above two posts that:
a) this is the time for concerted and strong reflationary action to avoid a depression, hence my expectation for the inception of co-ordinated rate cuts etc.. and
b) that the lending problem has become psychological and that the mind-set has become close that of the 1930s. If this is allowed to cement itself over time then a tremendously deep recession will be assured. I also agree with BR that
c) we will see a "race to the bottom" among the currencies as everyone prints and eases, and would note that
d) the strength of the $ reflects the liquidation and repatriation of emerging market investments and is purely a risk aversion trade.
Posted by: leftback | Oct 4, 2008 10:30:01 AM
Brian,
Never underestimate arrogance.
"My view is that improvements in monetary policy, though certainly not the only factor, have probably been an important source of the Great Moderation." - Ben Bernanke
Before you can reach the truth, you have to be able to say, "I was wrong."
Posted by: Winston Munn | Oct 4, 2008 10:36:24 AM
Proposal: Give foreclosure/bankruptcy Judges the authority to approve 10 year federal supplemental mortgage loans (principal and interest accruing) of up to 10 percent of the home value in instances where; a) the lenders voluntarily agree to write off existing mortgage loan balances by at least 10 percent, b) the judge determines that such loans are necessary to make monthly mortgage payments affordable to the homeowner (monthly P&I payments would be 20% lower, 10% from the bank write-off and 10% from the accrued federal supplemental mortgage loan) and c) the lenders agree to place the homeowners into a new 30 year fixed rate mortgage.
After 10 years, a sufficient amount of the new mortgage principal balance will have been paid off (16% of principal is repaid after 10 years on a standard 30 year mortgage), together with higher home valuations and homeowner incomes, to permit the refinancing of the accrued federal supplemental mortgage loan. The federal loans will be financed by Treasury Bill sales (of course) and interest will accrue at the T-bill rate.
I believe this proposal is somewhat similar to a proposal offered by BR earlier. In my opinion, it has the greatest potential for reducing foreclosure rates and increasing the value of outstanding mortgage securities. Homeowners would continue to make mortgage payments, but at a more affordable level, rather than simply walking away and saddling the banks with unpaid mortgages and foreclosure costs (as much as $50,000 per foreclosure).
The government would likely recoup its "investment" in mortgage-backed securities for this reason alone since many of the mortgages backing these securities would be taken out and refinanced. New mortgages would be less likely to default since monthly payments are more affordable and the federal loans provide a 10% cushion, somewhat akin to a down payment. It would be voluntary and thus preserves the sanctity of contracts.
Assuming a $20,000 average per loan cost, 5 million federal supplemental loans could be issued through the issuance of $100 billion in T-Bills. With the credit markets frozen, this is an opportunity for the federal government to serve as lender of last resort. It also is an opportunity to help mainstreet by permitting 5 million homeowners to save their homesteads and retain their access to credit.
Any comments?
Posted by: bsneath | Oct 4, 2008 10:52:45 AM
BR - if you were treasury czar today , what would your solution/plan be?
Posted by: Jay | Oct 4, 2008 11:07:02 AM
bsneath: Yes, definitely issue more Treasuries (I am short the 10-year). Seriously, we will probably arrive at the point of a direct negotiation between government and homeowner, and eliminate some of the money being lost by the Wall Street intermediaries. Not under this administration though.
Posted by: leftback | Oct 4, 2008 11:13:41 AM
Wha? Who? What? Low interest rates? Easy money? Plunged Wall Street into crisis? This is really an incredible nonsense. On the contrarily, there is a tremendous lack of liquidity and crisis of confidence. Therefore, injecting more liquidity and lowering interest rates is a good medicine, not bad.
With all due respect Barry, but you and your Grant should read a little bit more about history; in particular about the Panic of 1907, also known as the 1907 Bankers' Panic.
TED spreads and LIBOR are at the highest levels ever -- extreme fear and banker's panic. One needs to go back to 1907 (1907 Bankers' Panic) to see how the confidence was restored.
Panic of 1907
http://en.wikipedia.org/wiki/Panic_of_1907
Also see this Dow 1904-1909 chart
http://en.wikipedia.org/wiki/Image:Dow_1904_to_1909.png
Note how in 1907 the market came down to 1904 levels and completely recovered after the confidence was restored.
We are currently near S&P-500 2004 levels...
Coordinated global rate cuts (most likely announced this Monday morning) and Paulson's rescue package could be a similar turning point.
Yesterday after the package was passed, Bernanke said he plans to use his tools aggressively. He is planning for a coordinated global rate cut (before Trichet was the only party against it, but he is changing his mind fast after five European banks almost collapsed, and Ireland was forced to guarantee all Irish banks assets). Bernanke was waiting for the Congress to approve the package (otherwise, the boneheads would say that the package was not needed and would vote against it). Now, Bernanke is free to use his tools aggressively as needed, and he will.
P.S. Please stop embarrassing yourself by repeating Fleck’s nonsense that one year of Greenspan’s low rates policy is somehow responsible for the ten-year long housing bubble. Why don’t you try Clinton revising CRA and forcing the banks to lend to minorities and people with poor credit as the cause (that Roubini supported)? Greenspan’s policy was a catalyst, not the cause.
Posted by: Thomas Boch | Oct 4, 2008 11:21:27 AM
I disagree with James Grant, and agree with Gary Shilling who argues that we face deflation, not inflation. Commercial banks need even more liquidity than the Fed is creating. The amount of new money being printed is still far less than the vast amount of deleveraging and writedowns. The $60 Trillion derivative bubble is leaking much faster than the Fed can create new credit. Deflation will win over inflation, at least for the next year or so. Buy and hold government bonds, both U.S. and European, as well as GNMA's and CD's to weather deflation.
Posted by: Larry | Oct 4, 2008 11:25:25 AM
Grant is a great read and clearly understands the folly of the political/financial process. Credit deflation on a global scale is sending a message that will be reflected in our life style for decades.
Posted by: ron | Oct 4, 2008 11:25:50 AM
Will a rate cut really jump start consumption? Loosen interbank and commercial paper freeze-up? Improve bank solvency?
Unlikely.
Lurching from one ineptitude to another.
Posted by: mind | Oct 4, 2008 11:29:54 AM
Inflationists versus Deflationists,
It is interesting that the debate among those who saw the credit crisis coming is now is whether we will have inflation (Peter Schiff) or deflation like Japan (Mish).
But, whomever you believe, all are in agreement that things are gonna suck.
Barry, where are you personally on this inflation v. deflation thing?
Posted by: Rich Shinnick | Oct 4, 2008 11:33:50 AM
The $100 billion (10%) used in this fashion would save about $900 billion (90%) of existing mortgages from default. Not a bad return on investment.
Banks would actually save money since the 10% write-offs (about $22,000 per existing mortgage) is less than the cost of foreclosure (up to $50,000).
If you can add $900 billion of value back into the MBS assets, the banks are in essence recapitalized by this amount.
Therefore, $100 billion in supplemental mortgage loans can potentially have a greater effect in restoring capital in the banking system than does the $700 billion buy back plan.
What am I missing?
Posted by: bsneath | Oct 4, 2008 11:35:14 AM
Thomas Boch:
Sounds like you missed BR's CNBC appearance yesterday. You need to take the hint that BR gave to Charlie Gasparino.
Posted by: Joe Klein's conscience | Oct 4, 2008 11:35:56 AM
@bsneath
Although you propose quite a fine plan for keeping people in homes, the plan, IMO, does not address the real problem which is not about keeping borderline borrowers in homes but about home prices. (And, no, one does not equate to the other. Regardless of who stays or goes, home prices are too high.)
The problem is falling home values - the r-e-a-l problem is the destruction of mirage capital that was based on faulty home values that were unsustainable. The prices were a "mirage", a perception of value that was not real. There was no real money/currency to back the perception - hence, the term mirage capital - and why the destruction of "mirage capital" cannot be undone.
Money is nothing more than an exchangeable unit of labor. Our current worldwide debt-currency is based on a simple formula:
Borrower's Labor + Lender's Labor = Money.
When the borrower's labor (repayment) cannot equalize the repayment formula, default occurs and the formula breaks down, meaning there is no r-e-a-l money creation. What occured late in the housing rise was an alteration to the money formula: BAB (Borrower's ability to borrow) + LL = Real Money - and all the subsequent leverage based on this faulty formula was also unreal - a mirage.
That is why the monetarist approach cannot work - it cannot rebuild the basic formula once a substitute formula has been in play too long. The monetarists only method to fight this type deflating asset bubble is by financing a new and improved bubble.
As Grant points out, Hair of the dog....
Posted by: Winston Munn | Oct 4, 2008 11:44:54 AM
"I'm just trying to figure out when the police are finally going to show up and start hauling people off to jail.... "
If the OJ trial is any example, that would be 13 years from now...
Posted by: donna | Oct 4, 2008 11:46:44 AM
"Reserve Bank credit -- the raw material of bank lending -- is growing at the year-over-year rate of 61 percent. Credit creation is the Fed's signature crisis-management policy: Let a bubble inflate, then watch it burst; clean up with lots of dollar bills." -- James Grant
As Kid Dynamite said, economics has a technical term for this dynamic: pyramid scheme. The peoples' representatives (wipe that smirk off yo face) have decreed a radical, accelerated expansion of the pyramid, in response to the recent bout of clear-air turbulence.
Will it "work" (that is, to create another exhilirating dose of inflation and speculation)?
I lean toward "yes," simply because Usgov can still borrow at low, low nominal rates of between zero and four percent. Especially at the short end of the Treasury yield curve, where 3-month bills yield a miniscule 0.47%, the real interest rate is radically negative -- around minus 5%. So the more Hank borrows, the more the People make. [Laughs maniacally at this brain-busting paradox.]
So I say, let's just issue a TRILLION worth -- hell, make it three! -- of these fantastic 0.47% T-bills, which will cost us like NOTHING. And then let's go on a drunken spree from hell, and party till the purple dawn.
It's BUBBLE III, muthuh: the money's free; we're munching Brie; and I'm stoned outta my tree. Welcome to Weimar, my fellow Weimericans! Have a cigar, we're gonna go far. We're gonna fly high, we're never gonna die; they're gonna love us ...
Posted by: Jim Haygood | Oct 4, 2008 11:54:53 AM
YES...YES...YES!!
I agree "Low interest rates and easy money"
YES...YES...YES!!
The Banking Industry was deregulated in the early 80's in the guise of allowing it to compete more effectively with Money-Market Mutual Funds which at the time were able to offer slightly higher rates than Commercial Banks. Do you remember the story line. MMMFs were offering very high rates 14% to 15% or higher for a short period of time before Volcker was pushed out due to his inflation fighting agenda.
At that time, Banks were unable to compete with the MMMA. So what greater time than then to remove the requirement to pay a minimum interest rate on Passbook accounts. At the time, nobody even cared. Everyone was getting double-digit returns on their CDs and other money instruments.
But the big deal was not that the deregulation allowed for higher rates. The key component (missed by most at the time) was the removal of the requirement to pay a minimum rate of return on these Passbook Accounts.
After its passage, the rates Banks could offer were higher for a time. Depositors got higher rates and everybody was happy. The real intention of this Bank Deregulation was to deregulate market rates and in so doing eliminate the regulation requiring banks to offer minimum Passbook rates of 6.25% & 6.15% at Banks & Credit Unions, respectively. (These were the rates children "in-tow with Pah-Pah" received on their college savings held in Passbook accounts.)
The higher rates were short-lived and within a few years interest rates were actually below the previous floor set in the old Banking requirements.
Since the passage of Bank Deregulation, the cost of money (~interest rates) has been artificially manipulated by the Fed consciously favoring equities over more conservative money depositors.
This artificially lowered cost of money flowed into areas where it normally would not have flowed to. Projects on the margin would not have been funded if a more realistic cost of money figure had been used in the calculations.
IMHO, it all started way back there when they screwed the Passbook holders and within a few years completely removed it as any kind of reasonable place to store the value of the depositor's money.
The Bank Deregulation in the early 80's is but one small, but very significant act that set in motion the psychology of Americans to take their money from safe, low-return investments and placed them into more risky investments such as equities. If you put all the pieces together (that occurred throughout the years leading up to this point), it is fairly obvious we would eventually wind up here. There is a fairly visible trail that shows how Wall Street & the Banks have received favoritism for the last 26 years. Never being satisfied and always wanting more.
IMO, one could make a very strong case in which IF the cost of money had not been manipulated over the years (really since the removal of Volcker), none of this would have happened.
Posted by: BG | Oct 4, 2008 11:58:19 AM
