GWB: The Cash In The Cradle & The Silver Spoon - I’m Gonna Be Like Him

I try to avoid making unequivocal assertions…but if my instincts are correct, I’m not taking much of a risk in predicting that the calamity that will define this Bush presidency will not be the Iraq war. As with his father’s presidency, it will be the economy. Yes, the Iraq war will be factored into the equation that facilitated one of the worst recessions in modern times, but numerous other missteps will receive far more attention.

With the Savings and Loan scandal of the late 80’s as my point of comparison, I expect the magnitude of this recession to be much deeper and far more complex. Frankly, the fact that we survived events like the S & L scandal and the tech bubble have only contributed to the lackadaisical policies that have fostered an air of invincibility. This false confidence has resulted in a deadly conflation of economic poisons that will place a strain on our financial fortitude that hasn’t been witnessed since the Great Depression.

For months, the Bush administration has sought to convince the American public that the economy is sound. Unfortunately, the hollowness of those assurances expands exponentially with each new report. Today’s news is awash with further warnings of economic uncertainty. The President’s remarks, in response to the growing storm clouds, simply highlight the mindset that has typified his inclination to ignore information that doesn’t comport with his rose colored rhetoric.

Unfortunately, I fear this president suffers the misconception that he can tackle this systemic economic malaise in the same manner he addressed the many miscalculations that have plagued the prosecution of the Iraq war. Sadly, brute force has little relevance when it comes to the economy. As with the troop surge, the attempts by the Federal Reserve to pump more money into the economy in order to prop up flailing financial institutions fails to address the dire dynamics that underly the debacle.

Let’s pause to review the observations of others.

From The Wall Street Journal:

It is a very logical progression. Peloton, Carlyle, Focus — hedge funds and other non-deposit-taking financial institutions (NDFIs) are now being hit by the credit crunch, which had so far been mainly confined to mortgage lenders and the banks.

The Federal Reserve has reacted. Its Term Securities Lending Facility aims to encourage investment banks and prime brokers to lend to NDFIs and so relieve those parts of the credit market it cannot reach with its rate cuts and loans to banks.

So far its liquidity injections have got no further than the banks. Now it hopes to reach higher. Unfortunately, it won’t work.

The Fed is like King Canute with a difference — it is trying to halt an ebbing tide rather than a rising one. Its liquidity injection seems huge at $200 billion (with perhaps more to follow), but it is still only equivalent to one-third of the expected losses in the NDFI sector.

Moreover, the Fed’s readiness to accept almost any asset at just below face value as collateral will prevent price discovery. That means the U.S. financial system will remain burdened with uncleansed balance sheets that penalize future lending and economic growth.

Creating a lot of liquidity does not resolve an issue of solvency, which is now the driver of credit contraction. All the Fed will achieve is a dollar that will be further debased and inflation that will be higher. It cannot stop the process of deleveraging and asset price decline.

The credit crisis is unfolding as we expected, but more slowly than anticipated, because of the actions taken by central banks (mainly the Fed) and the U.S. government to allay its effects. The wholesale socialization of credit has meant that government and central bank measures account for 70% of new credit since last summer.

But these policy measures will not prevent asset-price deflation or credit contraction, which are functions of risk appetite and general readiness to maintain current levels of gearing throughout the economy. The non-bank sector has the potential to inflict more damage on the system than banks, because it has a much smaller capital cushion for a much more volatile and risky balance sheet.

Credit contraction translates through the financial system into a reduction in available credit for the non-financial corporate sector, and thus into reduced investment and growth in the real economy. The size of that contraction can be estimated from the leverage ratios of the financial sector and their impact on real GDP growth.

We estimate that nonfinancial corporate debt ultimately will have to shrink by 11%-12%. This will generate a decline of five percentage points of real U.S. GDP growth and push the U.S. into recession. Europe’s real GDP growth will contract by two percentage points.

Essentially, the point being made by the author is that the Federal Reserve’s efforts to lower interest rates is inadequate to address the fundamental problem - the value of the assets that underly much of the existing debt is in a period of contraction…largely as a result of the collapsing housing industry.

As such, the ability of lenders to lend is limited. They lack the capital needed to make loans; let alone the capital required to support declining equity positions and the increasing default risks that are associated with these loans. Hence, the Fed’s efforts to infuse the economy with the capital needed to spur growth isn’t going to be sufficient. Even worse, should this contraction lead to lender insolvency, the likelihood of the need for a huge government bail out advances. If this happens, I believe it will be far larger than the one witnessed during the S & L scandal.

From The New York Times:

The Fed’s economic power rests on the fact that it’s the only institution with the right to add to the “monetary base”: pieces of green paper bearing portraits of dead presidents, plus deposits that private banks hold at the Fed and can convert into green paper at will.

When the Fed is worried about the state of the economy, it basically responds by printing more of that green paper, and using it to buy bonds from banks. The banks then use the green paper to make more loans, which causes businesses and households to spend more, and the economy expands.

This process can be almost magical in its effects: a committee in Washington gives some technical instructions to a trading desk in New York, and just like that, the economy creates millions of jobs.

But sometimes the magic doesn’t work. And this is one of those times.

Instead of following its usual practice of buying only safe U.S. government debt, the Fed announced this week that it would put $400 billion — almost half its available funds — into other stuff, including bonds backed by, yes, home mortgages. The hope is that this will stabilize markets and end the panic.

Officially, the Fed won’t be buying mortgage-backed securities outright: it’s only accepting them as collateral in return for loans. But it’s definitely taking on some mortgage risk. Is this, to some extent, a bailout for banks? Yes.

Still, that’s not what has me worried. I’m more concerned that despite the extraordinary scale of Mr. Bernanke’s action — to my knowledge, no advanced-country’s central bank has ever exposed itself to this much market risk — the Fed still won’t manage to get a grip on the economy. You see, $400 billion sounds like a lot, but it’s still small compared with the problem.

Krugman offers a look into the risks being taken by the Federal Reserve to avert the looming collapse of financial institutions. The fact that the government is taking unprecedented risk signals the seriousness of the situation. The fact that the government has committed half of its available funds to this risk intensive effort suggests that the ultimate solution will require the government to appropriate additional funds…hence the bailout begins. The price tag of the S & L scandal would likely pale in comparison.

The impact to the overall economy could be mind-boggling since it would be apt to affect consumer spending. Falling home values would strip millions of Americans of the bulk of their accumulated wealth which would no doubt restrict their ability and willingness to spend money. The direct correlation of this intertwined cause and effect spiral could have disastrous consequences.

We haven’t even factored in the disproportionate numbers of baby boomers moving towards retirement. A worst case scenario could place the financial stability of many of these individuals in jeopardy at a time when the safety net of Social Security is also approaching insolvency.

From CNBC:

The United States has entered a recession that could be “substantially more severe” than recent ones, former National Bureau of Economic Research President Martin Feldstein said Friday.

“The situation is very bad, the situation is getting worse, and the risks are that it could get very bad,” Feldstein said in a speech at the Futures Industry Association meeting in Boca Raton, Florida.

“There isn’t much traction in monetary policy these days, I’m afraid, because of a lack of liquidity in the credit markets,” he said.

The Fed’s new credit facility, announced on Tuesday, “can help in a rather small way … but the underlying risks will remain with the institutions that borrow from the Fed, and this does nothing to change their capital,” Feldstein noted.

I simply don’t see the mechanism by which this strained liquidity can be alleviated in the near term. Pumping more cash into the system could have short term benefits but the risk to the already tenuous value of the dollar would likely outweigh them. Relying upon the standard bearers…the consumer…to spend us out of this mess seems unlikely. Rarely have prior recessionary periods been accompanied by such significant declines in home values.

Were we to see the emergence of sustained inflation, the picture becomes even more disconcerting. Many of the measures designed to address the liquidity crunch have the potential to do just that. Toss in our trade imbalance, the amount of debt held by the Chinese, and an international shift away from the dollar as the preferred reserve currency and one begins to see the growing alignment of negatives.

The fact that the American image has been tarnished during the current administration makes it difficult to imagine the kind of international cooperation we might have otherwise received during such a slowdown. In fact, don’t be surprised if a number of nations stand idly by as the perceived bully endures its comeuppance.

Returning to the Bush legacy, I recall the deteriorating situation faced by his father prior to the 1992 election. When the senior Bush expressed his amazement with the scanning technology found in grocery stores, his appeal and his connection to the average American is thought to have suffered. When the Clinton campaign added, “It’s the economy, stupid”, the stain became permanent.

The fact that the current president expressed surprise when a member of the press mentioned the prospects of $4.00 per gallon gas seems eerily similar to the last days of his father’s presidency…and it may also assist in cementing the economy as his legacy’s leading albatross.

George W. Bush’s seeming shortage of empathy for the plight of the average American shone through in his mishandling of Katrina, his passage of tax cuts for the wealthiest, his inept energy policy, and his willingness to sink trillions of dollars into the execution of a virtual vendetta in Iraq. These events will forever be tethered to his tenure and his successors are apt to spend years trying to repair the damage done.

They say the writing of one’s legacy is rarely finished since the past undoubtedly shapes the future. In the case of George Bush, I suspect he’d be best to hope that his influence on the future be less indelible than his unabashed attempts to color the present.

Gertrude Stein stated that a “rose is a rose is a rose”. Ernest Hemmingway responded with “a rose is a rose is an onion”. In thinking of the Bush legacy, I’m inclined to argue that a silver spoon may beget rose colored rhetoric…but a silver spoon full of rose petals rarely helps us swallow the thorns. When the bow breaks, the Bush legacy will fall.

Cross-posted at Thought Theater

7 Responses to “GWB: The Cash In The Cradle & The Silver Spoon - I’m Gonna Be Like Him”

  1. Jim Brown Says:

    Bush getting even for not giving him Social Security to fund his little war. Has anyone noticed that he seems to concentrate on retirement programs??

  2. Christopher Radulich Says:

    Isn’t amazing how we always hear about how capitalism is all about taking chances. It is the markets invisable hand that creates outr wealth.. Government should get out of the way and let capitalism do it’s work.Until , of course, they want the government to bail them out. then the government is no longer incaple of doing things right. Then the invisable hand of capitalism needs to be tweeked by government. Suddenly socialism and a command economy are no longer bad.

  3. rube cretin Says:

    “When the bow breaks, the Bush legacy will fall.” I agree the Bush legacy as captain of the American ship will be one marked by poor performance in every aspect. Unfortunately when the bow breaks more than than the captains reputation is at stake. The crashing economy and dollar, peak oil, high unemployment, failing businesses, and corruption by the captains of finance are just the early symptoms of very difficult times ahead.

    Perhaps its just the delusions of an old man, but i would wager 2008 is going to go down in American history as the year the fall began. Our free market capitalist system buttressed by a corrupt government wholly owned and operated by cooperations and motivated by greed has sailed the ship of state onto a reef and big storm clouds are on the horizion. While there have been many signs of the incompetence of our leadership, and the reality of diminishing resources on a finite planet, the passengers have essentially ignored them all.

    Personally, i don’t give a fuck about Bushes legacy. His body language, lack of intellectual curiosity, and stupidity are unfortunately a perfect reflection of the American psyche of arrogance, narcissism, and greed. We elected him and put him up before the world to see. He demeanor and actions are not attractive but it is truth. i am personally ashamed.

    Going back to the farm today. Spring garden is sprouting, fire wood needs to be cut for next winter, and compost needs to be spread. Advice from an old man. Make lots of friends. Purchase a good sleeping bag. Invest in gold, silver, ammunition, and whiskey. The economic future, which was the subject of this post, is going to be about community not competition.

  4. Liberal Jarhead Says:

    Along the lines of Rube’s closing paragraph, it might not be a bad idea to invest in the Foxfire series of books and start collecting tools, first aid supplies, and seed, too; and along with that sleeping bag, it’s a good idea to have a good tent (although it’s better to stay at home if possible, rather than becoming a refugee) and at least two pairs of high-quality hiking boots. And along with making lots of friends, get two or three good big dogs, sturdy and friendly breeds like labs.

  5. rube cretin Says:

    LJ
    “There was a cartoon a few years ago showing an old sailing ship going down fast by the bow…” another cartoon from a few years ago showed a couple of one cell organisms in the foreground and a giant mushroom cloud in the background. one of the organisms says to the other, ” O.K. lets start over, but this time no brains.”

  6. Jim Brown Says:

    Wonder what happened to the bail-out money for Bear Sterns. Is it an asset that goes along to the purchaser? Wasn`t there more of that than the purchase price? Hell, I could have bought it and made millions! Why didn`t I think of that???

  7. Christopher Radulich Says:

    If the government is going to assume 30 billion in debt why didn’t it take over the company?

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