The Aftermath


clueless

Good summary of the financial crisis and its aftermath. From Barrons:

Five Years on Fire

By THOMAS G. DONLAN

The disastrous events of September 2008 live on.

Five years ago last week, the U.S. Treasury yelled “Fire!” in a crowded theater by letting Lehman Brothers go bankrupt. The world of finance took up the chorus as it ran for the exit. The panicked crowd trampled the guilty and the innocent alike: banks, quasi-banks, nonbanks, money-market funds, bonds and stocks, and their investors.

There was no exit for any of them. The world financial system had become globalized, which is another way of saying we are all in a room with no door, called Earth.

As Jean-Paul Sartre warned in No Exit, his 1944 play portraying the eternal punishment of three souls by putting them in a locked room, “Hell is other people.”

When financial institutions heard the cry of “Fire!” they smelled smoke in their own attics, where they had stashed their dubious mortgages and their mortgage-backed securities. Financial engineering supposedly had made such paper safe as houses; in fact, it was all subject to spontaneous combustion.

What Could Be Worse?

Faced with the possibility that the Treasury (or the Federal Reserve or the tooth fairy) might not honor the implicit government guarantee of the financial system, the system swooned. Troubled institutions needed credit like addicts need dope, but nobody would lend to a credit junkie, least of all another credit junkie. It takes one to know one, and even without the help of credit-ratings agencies, they all knew one another very well, like scorpions in a bottle.

The government swooned next. Lehman Brothers was the only major financial institution allowed to go into bankruptcy, and officials quickly declared that it was all a mistake that would never be repeated—proving it almost immediately by propping up AIG with an $85 billion injection. We were on the brink of the Great Depression, according to then-Treasury Secretary Henry Paulson in the dark days of September 2008. He believed, and still believes, according to anniversary interviews, that nothing could be worse.

So far, there has been no repeat of Lehman’s debacle. “Too big to fail” is the reigning dogma of financial regulators and lawmakers, who pretend to tighten up the rules to reduce leverage and risk but shrink from forcing financial firms to take the consequences of their risky behavior.

For five years, the Treasury, the Fed, the Congress, and the White House have agreed on little, but they do agree that no more sparrows like Lehman shall fall—not by accident and certainly not on purpose. The eagles of Wall Street, of course, will soar. And even the gnats have an implicit government guarantee, as Fed Chairman Ben Bernanke demonstrated last week.

Since May, Bernanke & Co. had been publicly warning everybody within smelling distance that it was getting to be time to dial back or taper the Fed’s adventure in monetary stimulus. Suddenly, he reversed course.

Numbers Rule the Game

For those who have lost their way in the fog of euphemisms, the Fed’s policy has been known as quantitative easing, parts 1, 2, and 3, with Operation Twist tacked on for bad measure. In operational terms, the Fed and financial experts generally talk about the Fed’s buying $85 billion worth of bonds—Treasuries and mortgage-backed securities—every month, but that too is a euphemism. The Fed now works like a pawn shop, taking in unwanted assets and lending money in return. There are nine billion names and phrases for it, but only three are honest: monetization, money-printing and inflation.

The practical results, however, have been surprisingly small. Most prices have remained fairly stable—except gold, commodities, and stocks, which have been volatile with a bias to the upside. Economic growth has been lame. And without much growth, consumer income has been dull.

This was not supposed to happen. Whether a government stimulus is Keynesian, using spending increases and borrowing, or Friedmanesque, using money creation, it’s supposed to get the economy moving again. That it has never done so without a major war hasn’t stopped American economists from expecting better results from each successive replay.

That’s why the inflation policy won’t be tapered off just yet, even though the Fed’s optimistic forecasters had projected a growing economy that would let it be done without pain. Bernanke said this week the sluggish economic data convinced nine out of 10 members of the Federal Open Market Committee that the economy is too weak to fly on its own power without further monetary support from the Fed. He also claimed that Congress and the White House have been insufficiently stimulative on the Keynesian front. A few trillion here and there are apparently not enough.

Stock-market reaction to this turn of events was curious to anyone not a credit junkie: The Dow and the Standard & Poor’s 500 set new highs. A new shot was more vital than a new attempt to make the economy get straight.

Meanwhile the political parties are daring each other to shut down the government, or to stick to the debt ceiling they legislated earlier this year, or both. Bernanke rightly said that was an item of concern. It would be embarrassing if the Fed tapered and then felt forced to untaper.

Big Brave Words

Traders hang on every word from any Fed chairman, hoping for clues to what he really thinks. Even Bernanke’s stated policy of transparency hasn’t satisfied them. The chairman may say he eschews obfuscation, but sensible traders know that all central bankers prevaricate.

During No Exit, one of the characters tries over and over again to escape from the locked room. Near the end of the play, he tries one more time and the door opens. But then he won’t leave. Though he manufactures excuses about needing “absolution” from one of the others in the room, it’s clear that his real problem is fear.

Who knows what might be outside of the room? It might be worse than his current version of hell.

Bernanke and the rest of the American financial leaders surely know the feeling. They seek absolution while denying their guilt. Their fear is natural and pathetic.

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