Today’s Dip One was obviously the crash of the marketplace that started in 2006, but only began to be felt in 2007. This was when the daily escalation of prices, primarily real estate prices, and the buying and financing frenzy that supported all of it finally appreciated its own risks and the flaws of its own assumptions. It turned out that prices supported by little more than cheap, easy money and massive leverage are a puff of smoke and as such blow away almost instantly when the loan payable by everyone in the financing chain finally becomes due and no one in the chain has anything to pay with other than a pyramid of IOUs from debtors whose only asset is the same over-hyped, over-priced property which was sold them.
This happened before in the bloodbath this country (and ultimately the world) took between 1978 and 1985. To know where we are in the 2010s, it is instructive to go back to that time and review.
As we know now, the banking community was worse than myopic when it passed the 1981 Monetary Liberalization Act, lifting all legal ceilings from lending rates. Unregulated rates would have to go the same way as uncontrolled prices. Up. Up until prices fall and then finally up until no one can borrow. This is what killed the banking community in the late 1980s and it is waiting to do so again.
What the banking community and regulators of the 80s did not “get” was that deregulation of money loaned was also deregulation of money borrowed…and the banking community itself was by far the biggestborrower in town. They borrowed from depositors and other investors and the same deregulation that allowed them to lend at no ceiling meant that their cost of funds had no limits. And it accordingly went orbital. These were the days when a Super Now Daily Account had to pay depositors 9% to 14% as, otherwise, the money would go to Treasuries which, always unregulated and in direct competition and hungry to feed the big deficits left by Vietnam and the Great Society, were paying 9% to 12%! With the then 4% to 6% spread between cost of funds and lending rates required for a thrift or bank to stay in the business, resulting in a retail money-delivery rate of 19%, it was clear that doom was not in the early term, but in the longer term play-out of the Liberalization Act. The fact was, after the cost of funds and the spread needed to do business, there were no takers for those 19%-plus resulting retail money rates as nothing would pencil with them and the only ones who would sign loans like that were the desperate risk-taking, third-tier borrowers who were not really qualified for loans for the projects that would never make sense at the rate of finance, anyway.
The banking community thought the solution to bad local loan choices was to leave their communities to look desperately for (mythical) quality borrowers outside of it. Bankers from Littleton, Colorado, used to making local car loans, were suddenly flying out to meet high-flying speculators on massive mixed-use developments in Miami. Stupid loans with scant or no due diligence from naïve bankers was the norm. A portfolio occupied primarily by crooked borrowers on massive-sized defaulted loans was the entirely foreseeable result. In some scenarios, the bank was even a “partner” on the equity side, like an investment banker, which was even more ludicrous when many times that bank was a small merchant bank from Kansas that usually made farm loans.
Each time the banks raised their deposit interest to keep up with Treasuries, the competing Treasuries discounted deeper; each time the Fed yield went up, the Banks had to raise their cost of funds more to keep any money there. It all collapsed in early 1987. The RTC showed up with Federal Marshalls and locked the thrift and bank doors; thrift and bank executives did the “perp walk” down the streets to waiting barred vans; multi-billion dollar suits for recovery were filed against executives and directors by the regulators, and a few went to jail. Blood was let. The hatchet inevitably fell sooner than later. It was quick and it was….resolved. By 1991. But, important for us in the 2010’s, though theeffects were mercilessly interdicted and crushed, the causes, the liberalization was left intact.
Here is what the Feds DID NOT DO in 1986 and it is why a healthy market started again in March, 1991. They did not go back and refund losses to or recapitalize the lending and savings community, hoping for a different result by the repeating the same errors. Instead, as noted, after 5 years of regulatory pleading with the industry to consider working out troubled loans, to discourage REOs in favor of principal-reducing workouts and not expecting strapped borrowers to be able to pay more than they had or the property was worth—all falling on deaf ears—they created the RTC, closed the recalcitrant lenders, charged their principals with unsafe and unsound banking practices and took over and sold the majority of the assets without paying the defaulting lenders a dime for them—nationalizing and resolving about $2 trillion in assets after about $800 billion in regulatory deposit guarantees. This blood-letting restored the system to some semblance of balance and it was that system that pre-dated this last run-up when those lessons were lost. In sum, it worked then because the Fed went for the most part after the culprits for the crash—the banking community—and not the victims of it, the borrowers and taxpayers, as it is so misguidedly doing, today. There was no TARP money. There were bank closures and indictments. But even then it was not a systemic fix. The Fed disciplined the Bad guys, but it did not fix the rules that allowed them to be Bad. For the most part, it was because the Fed felt that there was still a major firewall in place that would automatically stop the worse of a potential economic double-whammy--a simultaneous failure in both banking and on Wall Street. It was the Glass-Steagall Act.
To understand the immense value of the Glass-Steagall Act, one has to go further back in time. Prior to 1933, the banking community and Wall Street were inseparably intertwined through management, shared portfolios, cross-collateralization and even common ownership. Consequently, the emphatic speculation and risk-taking philosophy usually associated with Wall Street did not stop there—it migrated into the predominant banking philosophy of the times, as well. Banks that were originally established to be “bean counters” and “guardians for the vault” separate and apart from the wild risk-taking world of Wall Street became scarcely recognizable from the wildcat speculators—only in the bank’s case, it was not using people’s risk-apprised investment money, but using people’s carefully conserved savings. Couple that cross-breeding with the political-economic “science” of the day (Adam Smith’s “Invisible Hand” theories hypothesizing that markets were “naturally self-righting when run without regulation in a self-interested world”) and it was popularly concluded by the best thinkers of the day that “business, left to the efficient self-regulation of an entirely arithmetic marketplace, would always correct itself, generating trickle-down prosperity for all” and what resulted was an almost unregulated privately-owned national economic system.
Then came the 1929 Great Crash and the following 25 years of Depression (even in spite of desperate “pump priming” efforts by the Roosevelt Administration, i.e. the experiment in “Keynesian Economics”) saved from failure only by the massive economic ramp-up caused by World War II. The Great Depression was never fixed by a Keynesian Recovery. It was subsumed by the massive money-spending and resource-consumption of the War.
Following the Crash of 1929, the national political reaction was the formation of regulatory bodies like the SEC, the FDIC, Comptroller of the Currently, Office of Thrift Regulation, National Credit Union Administration and other agencies, followed in kind by similar new regulators and regulation at the state jurisdictional level. Also, importantly for the present discussion, came the Glass-Steagall Act, adopted in 1933 in the wake of the crash of Wall Street and the national banking failure, which prohibited the incestuous kind of relationships between the equity community and the banking community that was seen to have “burned through dividing bulkheads” and having created the “multiple collapse” of both Wall Street and banking in 1929.
Glass-Steagall was to be the systemic “fire wall” between the speculation and risk of Wall Street and the ultimately conservatively warehoused capital represented by banking. It was what was relied upon in the bank clean-up of the 80’s. Had it not been there, had both Banking and Wall Street fallen at the same time, it was entirely likely the U.S. would have had its second and greatest Great Depression…and we would all likely still be in it, today.
The Act prevented Armageddon in the 80’s and worked well through smaller dips for 63 years. That is, until it was repealed in 1999 by then-President Clinton after intense lobbying to do so by both the Wall Street and banking communities (short memories). They contended (tragically wrong as was later proven by where we are today) in numerous technical analyses (1) that the U.S. was hobbled in its international competition by being unable to enter markets where there was no such limitations; and (2) unlike 1929, other regulatory forces (noted above) were now in effect that would “watchdog” for any of the former dangers and excesses. The thoroughly-discredited “Adam Smith” anti-regulatory argument from the 70’s also surfaced mildly, but cautionary economic memories were short and the expansionary political pressures were great. It was revoked and, instantly, the Banks could own Wall Street entities and vice versa. It was back to 1929 and this time, with the Monetary Liberalization Act, without even the usury limits that were in effect in 1929! A broker’s paradise! Moreover, the banks could now clearly work directly in partnership with Wall Street to endlessly generate and endlessly securitize and derivate debt. Broad-spectrum banking/Wall Street corporate inter-marriages ensued and the government license for the speculatory free-for-all of the 2000s was granted.
Thus began an ever-enlarging and ever-more-unfettered, ever-more-speculatory, ever-more-leveraged institutional lending/investment binge that centered primarily around liberal and poorly-underwritten bank-originated debt fed relentlessly by the ability to obtain immediate resale through boundless securitizations and derivatives from Wall Street. Banks turned into the mortgage brokers, servicers and general henchmen generating endlessly collateralized debt to be immediately sold promptly “downstream” to Wall Street rather than from and into the cautious proprietarial bank portfolios compelled of them prior to the Glass-Steagall repeal. Rather than keep reserves safely and conservatively, the “prop desk” inside the banks—the department doing their own proprietarial trades, put it all in Wall Street—along with depositor’s savings money, as well. Wall Street became the “insatiable buyer from endlessly-selling banks who cannot say ‘no’” as it sold piles of barely-vetted or entirely not-vetted loan-backed securities pyramids into what seemed to be a boundlessly unquestioning market. Who cared about quality? It was “some other guy’s problem downstream.” Caveat emptor (“buyer beware”) once again became king (Adam Smith, again). Rating agencies rarely saw an offering, pure or blended, that was not worth a “AAA” rating and regulators, led by Federal Reserve Chairman Alan Greenspan, considered a guru primarily by bearing a sage face while taking no action, never saw a systemic risk worth intervention or a bubble not worth feeding or an interest rate worth controlled raising to deflate it. This, even after the Crash of 1986 in which hundreds of banks were closed—a result of similar excesses excused in the early 2000s at the beginning of the recent run up (that just ran out) as an “anomaly of the hyper-inflationary times” considered “behind us” due to such measures as the deregulation of interest rates (see how tragically that played out last time under the Monetary Liberalization Act, above).
This transparently misguided “perpetual motion machine” finally, inevitably and predictably collapsed loudly in September, 2008, when Wall Street lost approximately 3000 points—almost 30% of its September 1 value, or $4.165 trillion in investor capital (most of it equities held by institutions and in retirement investments) within 30 days. A lot of bank worth to cover savings went with that. As a good deal of that equity was securitized holdings in collateralized debt even proprietarily owned by the banking and insurance community, the collapse of those institutions was not far behind. And it would have happened already, except for the temporary postponement of the collapse caused by the emergency intervention of TARP and the dirty little secret that FDIC does not have anywhere near enough money this time to cover the insured depository losses. If the Treasury lets on that the banks are broke, then so is Wall Street and, more to the point, so is it and so are we.
In an economic instant, then, in September, 2008, the advancements of 3 decades in capital development and management were washed out in an Economic Katrina lasting but a few weeks and which has yet to finally subside. Comparisons to 1929 make The Great Depression look like a cake-walk compared to this one. In 1929: the market loss was less than $1 trillion; the resulting Wall Street major brokerage house collapses were 10 (none of the larger ones); banks and “building and loans” and credit-union equivalents closures were 35%; unemployment was 12 million at peak. In the Crash of 2008, the washout appears to be (between banks and Wall Street) a staggering $14 trillion lost and counting, about 700 banks, thrifts and other depository institutions have been or will be closed, 5 major brokerage houses and over a thousand smaller ones have failed and been liquidated or sold, all of the largest mortgage purchasers and insurers have failed and have been nationalized, the largest warehousers are closed, and unemployment may peak in excess of 50 million.
This is more than a glitch. Just as in 1929, there has systemic meltdown so grave that it has hit entire governments. Greece bonds have functionally collapsed, soon to follow, Ireland’s, Spain’s, those in the Baltics and small Nordic countries, just for a start. It will get worse yet.
Let’s not pull any punches: With no limits, no “ceilings,” no firewalls, it took the Economic Gurus only 8 years under “deregulation” and the portfolio-chicanery, international financial buccaneering and piratical risk-taking it induced to founder themselves into the reefs of excess—and this time, taking the entire world’s economies right with them.
This was all tragic enough. But it was only an encore. It is the HISTORIC DIP of the 80’s and the holes that were left in “containing it” that predicated the PRESENT “DIP ONE.” Both the historic and present Dip One are now seen as the continuing and inevitable failure of the same economic stupidity: The insistence upon believing in the myth that, left to its own devices through financial deregulation, the private market will efficiently limit and regulate itself to the profit and justice of all of us. It won’t. This “Old West” sort of thinking forgot another and more bitter rule of the Old West. When the sheriff resigns, all the crooks come out for victims and their crimes become ever more daring and their booty ever larger when no cop shows up to interdict it. Don’t think those prosecutions of bank officers, directors and larger shareholders in the 80’s were missed in the bank boardroom. Visions of “perp walks” kept their head down for nearly 20 years! But then when the coast appeared clear in about 1999 with the repeal of Glass-Steagall and with it all the cops not only went to sleep but even lost their badges, the free-for-all started and this time…….it was anarchy.
Recall from above that part of what made the Crash of the 1980s deeper and worse was not just the elimination of traditional controls under the political mantra of “deregulation for its own sake” and not just a swallowing of the false economic premise that un-policed capitalism will somehow mystically and invariably produce prosperity. It was an effect of the insatiable government need for massive amounts of cash to fund the then enormous public debt. The lenders wanted to lend at a higher rate to catch up with inflation, the equity market rates and Treasuries; the stock speculators wanted no limits on their risk-taking methods to be able to exceed bank deposit rates with their equity yields; the government thus needed to borrow at any rate required to compete with both to meet the large public debt. Everyone thought that monetary and economic deregulation would give them the solutions and the edge to accomplish these goals, but, instead, the competition for the same funds made funds ever more scarce to find, ever more fickle to keep and the added-costs of doing that finally beyond what any market could pay. Moreover, hard money made soft asset values as prices had to adjust down to service more expensive debt. It could not last and it didn’t. In the end, most of the Thrifts (where the residential real estate loans were booked) and a lot of the banks collapsed and in the 80’s the Feds let them. These entities had become the home of every thing that had failed the worst--housing and consumer debt. Someone had to be blamed and something had to be chucked overboard and the Feds decided it should be the banking community and thus refused in large part to close it rather than bail it out for the simple reason that it was cheaper to nationalize the lender than back it. Accordingly, the Fed did not write a check to the lender as has been seen in TARP. Instead it took over all of the assets of the thrift or bank at no purchase payment to the thrift or bank at all—a complete forfeiture of all of its monies, loans and assets—the privilege of the Fed to do whenever in it sole discretion it determined that the thrift or bank was “unsound and unsafe.” The Fed then went on to cover uninsured deposits and then to sue the directors, officers and major shareholders of the lenders personally for the rest. They could opt to cut that loss by actions that dramatic in the 80’s because the fallout from the closures on the banking side were insulated by the firewall of the Glass-Steagall Act from also and necessarily sideswiping Wall Street. Had the firewall of the Act not been there and had the banks and Wall Street then been as entwined as they have become today (subsequent to the Act’s revocation), the Fed would then have had to reject closure and consider instead a bailout that saved both, a crushingly more expensive solution that would have generated more public debt than at any time in world history. And one suspected at the time of being so far beyond public resources and so likely to have financially up-ended the entire US and, virtually, the world, that it was dismissed in the 80’s as being preposterous.
Fast forward to 2010: The Glass-Steagall Act is revoked. Banking crises again strikes due to deregulation and all of the same excesses, but this time the fire is burning on both sides of the divide—banks and Wall Street, so that both are poised to collapse. Treasury and the Fed, staffed with cadres of ex-banking and ex-brokerage CEOs, instead of surgically closing the failures and prosecuting the rogues as worked in the 80’s, astoundingly opts instead to turn on the printing presses and make up all of the enormous losses—virtually betting the entire national farm on the Keynesian “pump priming” economics that failed in the 30’s!
So spending this kind of almost inconceivable money in the 2000’s--$4 to $14 trillion and counting—and money which the Feds not only did not have at the time but had no idea whatsoever as to how they were going to get it--the government is again in need of massive amounts of cash to feed the highest public debt in history for any country in the world. Only this time it’s not the Vietnam War consuming it, it’s the smallest most powerful financial clique and this country is transferring to it the largest body of wealth over known since the dawn of man, all in accordance with a back-room deal in which this country covers the Banks’ and Wall Street’s gambling losses from years of not just betting stupidity but outright criminality. “Heads we win, tails you lose economics.” This is where DIP TWO comes in and it’s right out of the 80’s playbook.
Dip Two is a replay of the 80’s. The government starts borrowing all those trillions and cannot find anyone to buy them unless it pays big, big rates for it. As the government pays ever higher rates to pay down the national debt, the banks raise their rates, as the banks raise their rates, equity has to produce more returns to keep investors. Money and loan rates skyrocket until no one can borrow money at all and no investment can pencil because the cost of debt eats all the gains. It all collapses once again as it did in the 80’s, but this time with one major and disaster-compounding exception. THIS TIME THERE IS NO GLASS-STEAGALL ACT TO PUT OUT THE FIRE. WHAT BURNS IN WALL STREET BURNS RIGHT THROUGH TO YOUR BANK AND WHEN YOUR BANK EMPTIES its LOAN VAULTS, WALL STREET IS OUT OF CASH. Add to this that FDIC is $3 to $10 trillion under-funded to meet even the insured losses that would arise by the twin failure, let alone the trillions of dollars more that would have no coverage at all. DIP TWO COULD VERY WELL BE “ECONOMIC ARMGEDDON”—ONE OF THE DEEPEST AND GREATEST DEPRESSSIONS IN HISTORY.
The Fed knows this and is bailing water out of this sinking economic boat like crazy, though much too little and far too late. To date, the Fed has tried to use the Discount Window and the Federal Discount Rate that comes from it, plus the manipulation of Treasuries to produce currently and almost non-sensically low interest, believing that low interest will induce spending. It hasn’t. In fact, it may even have retarded it. Why should anyone borrow today when tomorrow the rates might even go lower? In addition, since no one is buying assets and they continue thus to plummet in value, why buy today when tomorrow’s price might be 10% less and a week later less even than that?
The Fed gimmick telegraphs just how desperate the conditions really are and that it knows it. The current “Fed plan” appears to be to subsidize liquidity so heavily as to encourage arbitrarily low interest rates with a hope to “reinflate” lost equities by the use of “cheap money.” First, as noted above, that is what got us in this mess in the first place! Second, even if it did work, then it would only start a second speculative bubble, which only returns us to another crash. Third, time has run out on waiting for the market—the federal deficit is knocking loudly at the door (by statute TARP and other programs have to start the pay-back this federal year). Fourth, this time the Feds are in a real conundrum—on one hand they have to compete for investment funds by raising interest rates on public debt until they get almost all of them, on the other hand, if they compete to the point of destroying the banks or Wall Street, they can no longer close the banks or Wall Street as they are dominoes now with no Glass-Steagall firewall between them and in any event there is no more money to pay the resultant losses again even if they did!
By terms of the legislation that made the bail-out funds available, such as TARP, in Federal Year 2011, the Treasury must go into the international marketplace and sell Treasuries. This is a marketplace that is already underwhelmed by the dollar and already requiring other highly stable economies like Germany to pay 3%-plus (and the weaker ones 12%-plus). Then the banks will have to match or exceed the yields, then Wall Street will have to meet and beat. Then to beat the others, one will have to exceed them and then the others will have to follow. Round and around and so on.
And that means, ready or not, interest rates have to rise. And they will, dramatically. And the cost of debt will depress equity, i.e. more meaningfully for most of us, real estate. This, for example, is where the only change on that $400K mortgage at 4% on your now crashed-down $150K FMV house after DIP ONE is that in DIP TWO the interest goes to 12% and your house now drops to $90K FMV for that oppressive cost of debt. Oh yeah. And Congress is contemplating taking away even the residential interest deduction next year—perhaps so the offset for these shocking coming interest rates will not cut deeply into a tax demand which they already know is going to be sky-high? Do they already see it coming?
What Congress really needs is to do NOW is erect a legal dam for the coming flood of red ink by revoking or suspending the Monetary Liberalization Act and by reinstituting the Glass-Steagall Act—thus stemming any potential for runaway interest rates and at the same time compartmentalizing potential losses into smaller bites. And the US Attorney is far past due to start prosecutions against one hell of a lot of Wall Street and Banking people. To avoid a crime-wave replay, the crooks need to see that the sheriff is back in town. Next, lamentably, we need to toss out a failed government which has been tone-deaf to the misery on our streets and allowed with impunity a monied clique to pillage our wealth, our way of life and the very heritage we had hoped to leave our children. The midterm elections have certainly shown that the electorate has lost faith in the current regime and is ready for change….almost any change. Candidates for public office need to get the new message: “If you cannot fix it and damn soon, you’re gone!”
FROM BUST TO (YEP!) BUSTER!
So that’s DIP NUMBER TWO and it’s real, and without the steps above it’s coming and regrettably it is a far cry from a “dip.” It’s us, just climbing out of the first hole—the Big Bust of 2008—only to get pushed by interest rates and taxes back into a far, far deeper hole, caused by having to pay the most anti-democratic, illegal, nefarious, audacious, back-room ransom from taxpayers to Big Money ever funded in human history. Dip Two, if it comes, is nothing less than the Great Depression of 2012.