I've been expecting a headline about the Federal Home Loan Banks and got it today. These banks have been leveraging up and acquiring mortgages at a record pace since this financial meltdown began. This should come as no surprise to anyone who has followed my blog (here and here in 2007 and here again). Here is some of the news from this Wall Street Journal Online Edition article:

Financial troubles at some of the Federal Home Loan Banks are raising questions about how well directors of these institutions are supervising their executives.

A plunge in the value of mortgage securities bought by several of the regional home-loan banks has forced them to halt dividends and curtail funding for local housing projects. An annual report issued by the banks' regulator this past week says some of them "paid insufficient attention" to credit risks and haven't invested enough in information technology.

Unlike giant banks or government-backed mortgage companies Fannie Mae and Freddie Mac, the 12 regional home-loan banks draw little public scrutiny. Created by Congress in 1932 to support the housing market, they are cooperatives owned by more than 8,000 banks, thrifts, credit unions and insurers. Because investors assume the government would bail them out in a crisis, they can borrow money cheaply in the bond market.

If the home-loan banks ever stumble badly, U.S. taxpayers would be called on to "rescue yet another financial entity," warns Karen Shaw Petrou, managing partner of Federal Financial Analytics, a research firm in Washington. These banks have about $1.26 trillion of debt outstanding, putting them among the world's biggest borrowers.

Here is a quote from the FHLB press release:

Operating Results and Affordable Housing Activity:
For the 12 FHLBanks, the combined net loss for the fourth quarter of 2008 was $715 million, compared to combined net income of $846 million for the fourth quarter of the previous year. Combined net income for 2008 decreased 57.3% to $1.2 billion, compared with $2.8 billion for 2007. Combined net income for 2008 was reduced by other than temporary impairment charges of $2.03 billion on certain private label mortgage backed securities (MBS) and home equity loan investments, as well as $252 million of writeoffs/reserves on receivables due from Lehman Brothers Special Financing.

FHLBank Affordable Housing Program (AHP) contribution expenses equaled $188 million in 2008, down from $318 million in 2007, due to the decrease in earnings.

Each FHLBank actively monitors the credit quality of its MBS. If delinquency and/or loss rates on mortgages and/or home equity loans continue to increase, and/or a rapid decline in residential real estate values continues, more FHLBanks could experience further reduced yields or additional losses on MBS investment securities.

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Fed Loans Losing Value

This seems like small potatoes now, but those Bear Stearns and AIG loans made by the Fed aren't doing too well. As of May 6, the Fed is under water by over $8 billion. Here are the details:



On the other hand, Commercial Paper Funding Facility outstandings are down from over $325 billion in December 2008 to $164.7 billion, and down $50 billion this past week alone.

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More Bailouts from Taxpayers

I was reading this article in The Wall Street Journal, Online Edition today titled The Next Housing Bust and had to put down an "I told you so." Here is a quote from the article:

The FHA is almost certainly going to need a taxpayer bailout in the months ahead. The only debate is how much it will cost. By law FHA must carry a 2% reserve (or a 50 to 1 leverage rate), and it is now 3% and falling. Some experts see bailout costs from $50 billion to $100 billion or more, depending on how long the recession lasts.

How did this happen? The FHA was created during the Depression to help moderate-income and first time homebuyers obtain a mortgage. However, as subprime lending took off, banks fled from the FHA and its business fell by almost 80%. Under the Bush Administration, the FHA then began a bizarre initiative to "regain its market share." And beginning in 2007, the Bush FHA, Congress, the homebuilders and Realtors teamed up to expand the agency's role.

This should come as no surprise to anyone who has been following this issue. I wrote about this in December of 2007. Keep listening because there may be more surprises, especially from the Federal Home Loan Banks.

Thanks to Val Ivanson for the link!

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Is Fiscal Stimulus The Right Medicine?

The asset bubble in the United States that has recently burst has wiped out an estimated $13-$14 trillion of net worth between declines in stock and real estate prices. The impact of this value loss is working its way through the economy with dramatic effect. GDP has fallen at a rate of over 6% for the past two quarters, several sectors of the economy are on life support from the government and the Federal Reserve, and we are now entering the 17th month of a recession that began in December of 2007. We already provided an economic stimulus package of approximately $160 billion under the former administration, and we are now looking at a much larger stimulus plan under the current administration. There has been some debate over the effectiveness of fiscal stimulus. Those opposing it claim that fiscal stimulus (that is, when the government borrows to spend and/or provide temporary tax relief) crowds out private sector investment thereby hurting the real economy. Another claim is that fiscal stimulus is ineffective because money that gets to individuals through the stimulus is used to repay debt rather than spent so the economy does not benefit from the multiplier effect of a dollar being spent several times over. I believe fiscal stimulus is the correct response to today’s economic situation, even if a large portion of it goes to repaying debt.

To work through the current situation we need a few economic basics. Individuals earn income. We spend some of this income and we save some. When we save we provide a source of funds for businesses to invest. Our savings flow to businesses through the financial system and the institutions that make up the financial system. Banks are the prime example. Banks take deposits and then use those deposits to make loans. Businesses borrow from the banks to invest in new opportunities. The stock market is another example where businesses raise equity capital to invest from the savings of individual households. Business investment means more jobs and that means more income, more spending, saving, and so on. This is how the economy grows in normal circumstances. Today, however, circumstances are anything but normal. For a long time we borrowed from our future income to consume more in the present (and support a price bubble) running up household debt relative to our incomes. We borrowed for lots of reasons, but the primary asset we borrowed against was our real estate. To put this in perspective, our household debt (that includes mortgages, credit cards, auto loans, etc.) to disposable personal income (that is, income after taxes) has increased from 66% in 1983 to 135% in 2007. The graph below shows the trend in household debt to disposable personal income (debt-to-income) from 1977 through 2008.


(DPI from BEA.gov. HH Debt from Federal Reserve Z1)

The debt to income ratio peaked in 2007 at 135%. It has since fallen back to 130% by the end of 2008. 76% of the debt was mortgage debt in 2007 as opposed to 66% in 1987. The 2008 decline in the debt-to-income ratio illustrates the fact that people are now borrowing less than they were relative to their incomes. The lower level of borrowing means less spending. In addition, we have begun to save again. While we were on our borrow-and-spend spree of the last decade we also spent more of our incomes and saved a lot less. The next graph illustrates the trend in the personal savings rate.


(Personal Saving Rate from BEA.gov)

From this perspective we now see the impact of the rapid declines in housing and stock prices. This mountain of debt, concentrated in mortgage loans, is no longer supported by the price of the underlying collateral. Many homeowners owe more on their home than it is worth and the home as a source of collateral for borrowing additional spending cash has dried up. In addition to this balance sheet impact there is also the cash flow impact. As payments adjust upward incomes are squeezed making it difficult to spend or to borrow more. It’s like a huge number of families borrowed as much as they could and blew it on a mega-vacation and are now saddled with paying back the debt for years to come. Finally, there is the wealth effect. If you thought you had a large portion of your retirement needs accounted for in the value of your home and investments in stocks you are feeling a lot less wealthy today. For all of these reasons households have switched from borrowing and spending to saving as illustrated by the personal savings rate turning up and household debt-to-income ratio turning down. So, this sounds like we are on the right path. If everyone saves we will eventually pay down the debt and everything will be OK, right? Wrong.

Welcome to the paradox of thrift. Saving is good for individuals and for the economy. Remember that savings becomes investment and that helps the economy grow. But when everyone increases saving at the same time overall spending goes down. As we collectively start saving and stop spending business contracts. In this environment business investment falls because there are fewer good business opportunities. So, at the very time individuals start to save businesses don’t need the savings for investment. This is why I do not believe that government stimulus crowds out private investment in the current environment. When businesses are investing less there is nothing to crowd out. And when businesses aren’t investing, people aren’t finding new jobs. As more businesses cut back, more people lose their jobs and can’t find new ones. That means less spending again, and that leads to less investment, and fewer jobs, and so on. This is one way economies fall down into long-term underutilization. How far down and how long depend on a multitude of factors, including the size of the bubble that burst. The losses in tax revenue and other costs to society can be very dramatic. So what do we do about this problem?

Enter the Federal Government, the one borrower that can raise cheap money when everyone else is too worried to borrow and/or can’t find anyone willing to lend (the willing to lend problem is the other side of the rescue plan - repairing bank balance sheets to assure loan supply). As the government spends the money it borrows it provides income to individuals just when individuals need the income because many are losing their jobs and needing to save. If the government provides enough stimulus it may stop the downward spiral of lower incomes and investment discussed above. If those receiving income from the stimulus spend the income there will be some immediate impact on demand in the economy and that could help jump-start business investment. On the other hand, if those who receive the income from the stimulus use it to pay down debt there will be less of an immediate impact on the economy but incomes will be supported while individuals pay down debt. Once debt levels are back to normal individuals should return to spending more of their income. In effect, we are replacing private debt with public debt by providing income through fiscal stimulus to avoid the potential devastation that can result from the de-leveraging of household balance sheets that needs to take place. So even if the recipients of stimulus income use the money to repay debt the economy benefits from the resulting de-leveraging necessary for economic activity to return to normal.

In the end, whether fiscal stimulus is a smart investment depends on its impact on the economy. If it helps to prevent a long protracted depression but costs less than a long protracted depression would, then the stimulus provides a positive economic return. Of course we will never know the true cost-benefit analysis because we will have no way of measuring exactly how much of an economic downturn was prevented.

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Income Inequality

This link is to a summary of research on income inequality in the United States since WWI. I have looked at similar issues on this blog in the past, for example here. This research is much broader and covers a much longer period of time. I think it puts the issue of income inequality into historical context and provides a good understanding of where we are today. For the full report you can visit the authors website here.

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Are We There Yet?

An Opinion Piece.

I started writing about the subprime crisis back before it was a crisis. I was warning of taxpayer bailouts on the way and pointing fingers at those I believe to be responsible for the massive increase in household debt over the past decade. Since last September, however, I have stepped back because we ended up in a true financial crisis – one that could have seen the shut down of credit cards and ATM machines across the country. In such circumstances I give the authorities a pass as I do not want to find out first hand what happens when the grocery store shelves are bare (I do not own a gun). At this point, however, I think we have averted the total collapse scenario. I am not bullish on the economy or the stock market just yet, but I am no longer worried that my access to cash will be shut off. If we have indeed averted the nightmare and are now on the road to a long recovery period, then it is time to go back to asking the tough questions about how we got here and what to do about it. I think we have arrived at this point and it is time to start holding people and institutions responsible for what has transpired.

I am very angry with some of the back door dealings and subversions that have occurred in connection with bailing out financial institutions at the expense of United States taxpayers. From Paulson's "no review" $700 billion bank scheme to revelations regarding the disposition of taxpayer funds through AIG, the manner in which this situation continues to be handled is, I believe, a disgrace. For example, when I hear Goldman Sachs tell us that the $12.9 billion or so it received from AIG through taxpayer funds was unnecessary because it was properly hedged against AIG risk I automatically think, "well, OK then, give it back." So where is it? The arrogance and insensitivity to the general public is obscene. What we have had is a devastating bout of bad behavior by our financial and political institutions. What we need now is to find those responsible, hold them to account, recover the proceeds of their ill-gotten gains the best we can, and prevent this from happening again. This is in addition to shutting down the insolvent institutions before they create even more bad loans in their attempts to become profitable. So far I don't see any of that happening. What I do see is Citibank charging friends of mine 30% interest on their credit cards while at the same time this institution has access to virtually free money from the Federal Funds market and infusions from taxpayers on giveaway terms. This is too much for me to reconcile even with the current financial crisis and the pressure on the banking system.

There are several things that currently trouble me a great deal. The back-door contribution of taxpayer funds through the toxic asset purchase program to the very financial institutions that perpetrated this massive destruction of household and financial sector balance sheets for private gain bothers me. The very fact that Timothy Geithner is Treasury Secretary after his tenure at the New York Fed during the creation of this crisis (not to mention his tax "issue") is troubling. The push to concentrate regulatory power into the hands of the Federal Reserve, the very institution responsible for overseeing our financial system during the drive to leverage up the United States household and financial sectors for the profits of the financial sector (and, more directly, those individuals within it) seems out of touch. The "modification" of mark-to-market rules is shady. The blatant conflicts of interest when the former and, as suggested by Matt Taibbi, the current CEO of Goldman Sachs construct a taxpayer bailout for AIG that provides the most financial gain to - Goldman Sachs - is astounding. The refusal to take the steps we ourselves tell other countries they need to take in times of financial crisis is embarrassing. (For a good read on this point see This article by Simon Johnson in The Atlantic.) These are momentous events, and though I detect the populist rage (for example, this piece by Matt Taibbi in The Rolling Stone) it seems to me that we as a population are at risk of letting this entire affair pass us by without holding anyone accountable or truly learning the lessons we need to from it.

I think we are there – at the point where we begin to take seriously the need to recall the army of finance, accounting, and legal experts who are compensated with outsized rewards to find ways they and their clients can circumvent the regulatory schemes put into place to protect us from this very problem. Those brilliant thinkers who can conceptualize the gray areas between legislative and regulatory words and intent to find avenues of attack for profitable private gain without concern for the impact on the population at large – the public risk. We also need to cleanse the system of the influence money, in all of its cancerous forms, that results in politicians carrying the torch for a favored industry. This will require at least two steps. Step one is to find out exactly what happened, who knew what when, and hold those who behaved recklessly to account for their actions. It is easy to find out who they are – just follow the money while ignoring the cries of "witch hunt" and "class warfare" that will be shouted in protest by those responsible (and their shills). Step two is develop a set of regulatory rules and enforcement that are principals based where actions that are contrary to the spirit of the regulatory framework bring swift consequences. The regulatory changes must address both the finance industry and the political process to remove the incentives for reckless legislation and deregulation. For example, if you are a business that borrows short term funds and invests those funds in longer term assets for profit, you are subject to regulation whether you have a bank charter or not. If you provide any assurance against the risk of loss you are an insurance company. If you engage in any of these activities without registering to be regulated you are promptly shut down, fined, and prosecuted. Once registered you are subject to capital requirements and oversight. Ultimately, these are the things that need to be done.

The more we allow taxpayer rescue of financial institutions without holding those institutions to account from this point forward, the more we are doing a disservice for the American taxpayer, and the more likely it is that we will pass through this crisis into another one in the future. I believe we have arrived at the point in time when we should be swiftly moving from crisis aversion to long-term cleanup – lets get started. I hope the Obama administration, as infiltrated as it already is by insiders from Wall Street, steps up to the plate and begins to take charge. The approach to the auto industry last week was a refreshing wake up call that there is a limit to what taxpayers will stand for. At the same time it highlights the enormous benefits bestowed on the financial sector even after such monumental failures, and the concurrent lack of accountability for the devastation on our economic lives. I want accountability and I want it at the institutional and individual levels. I want a complete investigation by qualified independent investigators. I feel that until we demand it we are no better than those who should be held accountable because we are being complicit.

*A note on my belief that there are specific people to be held accountable:

I believe that any seasoned lender understands that you cannot turn a package of bad loans to people with no income into an AAA security through "structuring." At some level, people had knowledge that what was going on was bound to collapse at some point. Perhaps the analyst didn’t, perhaps the loan officer didn’t, but at some level people knew what was transpiring. I don’t really care if they had insurance from AIG, they should have demanded to see AIG’s total exposure and taken that into account. What happened represents, at the very least, reckless activity and I believe could be characterized as fraud in certain circumstances. The facts revealed in the very incomplete "investigation" into the rating agencies participation in this mess revealed this to be true, and I would bet that any true investigation into the behavior of the financial institutions involved would result in similar findings. This Bill Moyers interview of William Black provides an interesting perspective on whether or not fraud was actually involved. In any case, whether what happened meets the legal definition of fraud is something we should be investigating and, if the answer is no, then we probably need a new definition or standard to protect us from this behavior in the future.

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GM and Washington - Finally an "Adult" Response

I just finished listening to President Obama’s speech regarding the auto industry and I found it refreshing compared to the rhetoric that has been dealt us up to this point. It sounds to me as though we are headed for a pre-packaged bankruptcy for GM with the government standing in as the DIP financier. This is what I thought should have happened in the first place, but I think the last administration kicked the can down the road. Thankfully, down the road was an adult who picked up the can to begin cleaning up the mess.

Of course this will mean some disturbing things, especially for union employees. In particular, this probably means lower wages and cuts in benefits to both employees and retirees. Even if bankruptcy is avoided the stakeholders are now under intense pressure to give up ground. It’s hard to see how we get back on track when we cut wages – this doesn’t help stimulate aggregate demand. In fact it enforces the deflationary momentum. (Hold on, I need to mute the television. That Kudlow guy is on making some noise about this. How is he still a commentator on CNBC after being dead wrong about almost everything over the past couple of years? Goldilocks economy my a$$.) Anyway, I am encouraged that the administration is taking what I consider to be the correct position on the automakers even though there is downside on the wage front. The entire mess brings the issues of trade front and center, and I expect this will be one of the most difficult dances for us to do. Is it too late to stop pushing the US down to a Global wage or can we somehow reverse this trend at a time when we need the world to finance our bailouts? Any thoughts?

Stay tuned.

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AIG - Where Your Money Went

The table above shows a summary of the payments disclosed by AIG Sunday. For the detailed list you can go here.

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Federal Home Loan Banks Leveraging Up

I haven’t read anything about the Federal Home Loan Banks since they published their preliminary third quarter results. This is just a short post to point out that Total Assets to Total Capital has been increasing while total assets (these are typically loans to banks) has been increasing dramatically. This is one of those places where taxpayers are leveraging to replace private debt contraction. To put this into perspective, I posted a couple of graphs. The first is Total Assets and the second is Total Assets/Total Capital, which hit 25 times in the third quarter. This is looking more and more like one of those investment banks, especially since almost all of the assets are mortgage related.


For additional information you can go to the FHLBank website here.

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The Money Supply And The Credit Crisis

I have been reading about monetarism around the web lately and find the topic interesting. Most of the writings I have seen look to money supply measures as an indicator of whether we should expect inflation and discuss the monetary aggregates, M1 and M2. Some commentators are stressing that M3 and MZM are better indicators of the true money supply as they include institutional money market funds ("IMMFs"). I agree with this position, but I think it misses some issues of the current economic situation. I think of it this way: Under the traditional model of monetary expansion the Federal Reserve injects reserves into the banking system which then uses the reserves to make a loan. The proceeds of the loan are then deposited into a bank and this is new money! The bank receiving the deposit can use a portion of this new deposit to make a loan, and the proceeds of that loan will be deposited into another bank – more new money. This process continues expanding the money supply and debt, limited by the portion of each new deposit that must be kept in reserve rather than loaned out and the fact that in order to make a new loan, banks need capital. But what if debt could expand without expansion of the money supply or bank capital? There would be a decoupling of the relationship between the money supply and debt creation. This decoupling has happened as debt that is originated by banks is often removed from the balance sheets of the banks through securitization, and this process converts the money supply from M2 to M3 or even out of M3 completely. To see how this happens requires a rather lengthy diversion into an example, so here goes:


To see how an everyday transaction ends up converting M2 to M3, I have drawn the diagram above. Beginning with the asterisk in Bank Reserves and assuming the Fed has injected $100 in new reserves, the Bank would want to make a loan for $100. Assume the Bank makes a loan of $100 to Home Buyer to purchase a house from Home Builder. Home Buyer takes out the loan and the cash goes to Home Builder. Home Builder now takes the cash and deposits it into the Bank. (These transactions are the black lines.) This is a new deposit and it represents growth in all the monetary aggregates. But in today’s financial markets (at least before the current meltdown) the Bank is likely to sell the loan to remove it from its balance sheet. If it does so by selling the loan (either directly or through a securitization first) to a commercial paper conduit, then the blue lines would represent the transfer of the loan in exchange for cash. But where did this cash come from? Let’s assume Investor took $100 out of its account at the Bank to purchase a share in IMMF (institutional money market fund) (the red lines). IMMF used this new cash to purchase commercial paper from the Conduit, which is where the Conduit got the cash to purchase the loan (the green lines). At the end of this series of transactions, there has been no net change in bank deposits because $100 went in from Home Builder and $100 came out from Investor (no change in M1 or M2). The original $100 of reserves injected into the bank by the Fed has been replaced by the proceeds from the $100 loan purchase by the Conduit. The money supply has grown, but it is what used to be M3 that increased through an increase in IMMF balances. The Bank is now free to lend the entire $100 again, effectively eliminating the reserve requirement and bank capital as a limitation on money supply (M3) growth from the initial reserves. Because of this off-balance sheet financing of loans by banks it can be M3 that increases as loans are made and sold rather than M1 or M2. Also note that this financing structure is speculative, funding long-term assets with short-term debt. Since the funding source (commercial paper) is not generally guaranteed (as are bank deposits) it is prone to a run. If the bank simply securitized the loans and sold them directly to investors without a commercial paper conduit we could diagram the same result with respect to M2 without an increase in M3 or MZM, but it would not necessarily be speculative. In any event, we have already created the money underlying the loan, but we have converted it to something that is not measured by M2 and sometimes not measured by M3. Because of these conversions of money from one form to another the traditional concepts of money supply and monetary expansion have been altered. As debt creation escapes the bounds of the monetary system around which traditional debt expansion occurred we should monitor debt outside banks as well as M2 or M3.


To see the change in the relationship between deposit expansion and debt creation I compared M2 to non-federal-government debt (“NFGD”) using the first graph above. (NFGD is all debt less federal government debt.) NFGD has increased from a multiple of approximately two times M2 in 1980 to over 3.2 times in 2007. Historically, as debt increased through the banking system there would be a concurrent increase in M2 as the fractional reserve system of banking would multiply the monetary base through deposit expansion. Today, however, deposit expansion and debt expansion have become decoupled as banks sell loans to third parties. In addition to decoupling deposit expansion from debt expansion, the latter is no longer constrained by bank capital since the banks are no longer accumulating loans that require capital. This can create a monetary base outside of the traditional measures of money.


We have also seen a decoupling of the relationship between incomes and debt creation. In its simplest form this is the relationship between debt and GDP. The second graph shows NFGD as a percent of GDP and M2 as a percent of GDP. The divergence is striking, and I think gets to the heart of our economic crisis – the breakdown of the relationships between money supply and debt and between debt and income. With debt ballooning to new highs relative to income, the cash flow implication for consumers is less consumption and more saving – a recession. But what supports this balloon of debt in the first place? In part it is like any other bubble - the rising prices of the assets being financed by the debt provides collateral for more debt. The difference with this bubble, however, is that we have gone from a game where the ultimate size of the monetary bubble is regulated by the Fed through banking reserves, deposit multipliers, and bank capital to a system where any bubble can create its own monetary supply to support itself using securitization to multiply bank reserves in a virtually unlimited manner. At the same time we should be monitoring broader measures of monetary expansion because of financial innovation the Fed has stopped publishing M3 in the belief that it adds nothing to what M2 tells us.

So, other than restructuring how we monitor the financial system for the future, what should be done? Lets start by recognizing that doing nothing is unacceptable as the risk of a deflationary spiral is too great and the results too dire to chance. Once consumers are overburdened with debt service we should expect a recession because not only will consumers save to pay down debt, they will stop borrowing while they do so which will further reduce consumption. Reduced consumption could lead to falling incomes and prices, in which case relative debt burden increases making things worse. Assuming savings also decline through falling asset prices (stocks, home values, etc.) there would be no reason to expect an increase in consumption (save the increase in the value of cash net of the value of liquidity, if any, in such circumstances) or investment, and we could get stuck in a long-term underemployment of great proportions. If the true driver of the current financial crisis is the creation of too much consumer debt, then the only way we exit the crisis is by reducing the burden of the debt on consumers through some proactive means. There are several ways to go about reducing the burden of debt-service on consumers (other than simply using public funds to repay private debt). (1) We can try to inflate our way out of the impending cycle of deflation and recession by adding reserves to the banking system, but this assumes more reserves will result in more borrowing, investment, and consumption. Will companies borrow to invest when the economic outlook is dreadful because consumers are overburdened with debt? Will consumers borrow to consume when they are already overburdened with debt? In short, will traditional efforts to expand the money supply expand the money supply? The evidence is not in yet on this front. (2) We can make every effort to lower interest rates thereby supporting asset prices and reducing debt service payments. This would help to reduce the debt-service in the debt-service/income ratio and provide more income for consumption. The Fed’s efforts to reduce both short and long term interest rates should have some positive impact on reducing the debt burden by lowering rates and, therefore, debt-service payments and should, in turn, support asset prices. Note this is related to the inflation scenario in that monetary policy easing means lowering interest rates on the short end. The Fed has now gone to purchasing long-term securities in an effort to reduce long-term rates that have not responded to the short-term rate reductions. We can also attempt to restructure debt obligations so as to reduce the current payment obligations of consumers by, for example, extending the term of a loan. (3) We can have a major fiscal stimulus that creates employment to increase incomes relative to legacy debt-service. By increasing incomes the debt-service/income ratio would decline. The stimulus would, in effect, replace private debt with public debt, freeing up income for consumption. Based on recent reports, a major fiscal stimulus plan is probably in the works by the new administration.

While we wait to see if our efforts are successful, we can utilize the Fed and Treasury to (i) pump public money into bank capital so the banks have enough capital to make new loans when they hold excess reserves, and (ii) lend to ever increasing elements of the financial system to prevent major systemic collapse as speculative financing evaporates. None of this is news.

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Is M3 Important?

There is interesting discussion on Paul Krugman’s NYT blog today regarding monetary expansion and the Great Depression. For the current crisis, I think you need to look at the divergence of M2 and M3. As institutional money market investors fund commercial paper that funds asset sales by originators, M2 is converted to M3. The money multiplier becomes unlimited as the original reserves used to fund loans are returned in full to the banking system with no new net increase in deposit liabilities. What’s happening right now is the reverse – M3 is liquidating and the monetary base is expanding to, in part, accommodate the conversion. If you look at Institutional Money Market Funds on Z.1 you will see the reductions in this (and, I believe other) components of M3 relating to credit expansion in the modern financial system. I have been waiting for the next Z.1 to confirm these movements.

I believe M3 is important, notwithstanding the Fed’s decision to stop publishing it. I have not concluded that the M3 expansion is the cause of the bubble, but it certainly shows how monetary expansion and, in particular credit expansion, contributed. I plan to post more on this after the holiday weekend.

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Credit Markets

I have heard commentators (Larry Kudlow) making the argument that the credit markets are working OK because bank loans are up by some pretty high numbers. That got me wondering, so I looked at the percentage change in total bank credit plus asset-backed commercial paper from end of September to end of September the following year. The data include Loans and Leases in Bank Credit based on Statistical Release H.8 from the Federal Reserve (the "Fed") and asset-backed commercial paper outstanding from the Fed's Data Download Program. (In 2006 I had to use the October ABCP outstanding due to a gap in the data.) The first graph shows the results.

(Loans and Leases in Bank Credit plus ABCP)

As illustrated by the graph, total credit growth is actually quite meager. The true situation is, however, much worse. I illustrated this by taking out of total credit in 2008 outstanding loans made by the Fed and securities lent to dealers*. In other words, I am trying to isolate the private banking system itself as if the Fed's loans were to be repaid (of course, they cannot be). The second graph shows the result.

(Less Fed credit)

Credit coming from the private system is down - a lot - not up. Without the Fed's interventions we could be bartering by now. Now, there are a lot of other pieces to the puzzle, but this is certainly a more troubling view of the credit markets. Granted Mr. Kudlow was referring to the most recent 13 weeks, but if you calculate credit the way I have I still do not see any increases in credit coming from the private banking system.

* This includes the net Repo position of the Fed, the TAF, the PDCF, the Bear Stearns loan, loans to AIG, the TSLF, and the new asset-backed commercial paper financing. It does not include the new facilities announced by the Fed that are scheduled to begin Monday for the purchase of commercial paper and, as of the other day, other assets by the Fed.

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Credit Problems Beyond Subprime

When the subprime credit crisis began to unfold in 2007 I believed it was a sign of deeper problems in the credit markets. Easy money and unchecked leverage puts pressure on banks to lend. First they make the good loans, then the not so good ones, and then they make bad loans. So far most of the media attention has been on the subprime mortgage crisis. Last week, to little fanfare, the Shared National Credits Program released the results of its review of loans to corporate borrowers that are shared by banks in the US, banks overseas, and other institutions such as pension funds, hedge funds, and insurance companies. The review is of:

loan commitments of $20 million or more and held by three or more federally supervised institutions

The review shows considerable deterioration in credit quality of these loans.

Criticized credits increased $259.3 billion and represent 13.4 percent of the SNC portfolio compared with 5.0 percent in the 2007 SNC review. Credits rated special mention (potentially weak credits) increased by $167.9 billion and represent 7.5 percent of the SNC portfolio compared with 1.9 percent in the 2007 SNC review. Classified credits (credits with well-defined weaknesses) increased $91.5 billion and represent 5.8 percent of the SNC portfolio compared with 3.1 percent in the 2007 SNC review.

Even more interesting is how the criticized loans are distributed:

Classified credits held by non-bank entities increased to $70.0 billion from $34.8 billion and represent 42.9 percent of classified credits. The volume of classified credits held by non-banks is particularly significant given their relatively small 19.9 percent share of the SNC portfolio.

The distribution could be due, in part, to purchases by non-bank entities of credits at a discount from face value but the report is silent on this point.

So what does all of this show us? It demonstrates the fact that subprime was one area of the credit binge of the past few years. Subprime is certainly a very big part of the credit crisis, but it is not the only part. Here is what the review states about underwriting standards for these $2.79 trillion of loan commitments with $1.2 trillion outstanding:

For the second consecutive year, the review included an assessment of underwriting standards. Examiners again found an inordinate volume of syndicated loans with structurally weak underwriting characteristics particularly in non-investment grade or leveraged transactions.

Add to this portfolio and mortgages all of the other loan portfolios, including credit cards, auto loans, corporate loans, small business loans, and so on, and this crisis goes well beyond subprime mortgages. Just how far is impossible to tell, but the rapid deterioration in the portfolios of major banks, such as the loss reserves announced by Bank of America, give us an indication. As reported in The Wall Street Journal Online Edition:

The nation's largest retail bank reported net income of $1.18 billion, or 15 cents per share, down from $3.70 billion, or 82 cents per share a year earlier. The results were worse than expected. Credit losses on mortgages and credit cards dragged down the results. Its provision for credit losses was $6.45 billion, up from $5.83 billion in the second quarter. Net charge offs were $4.36 billion, as compared to $3.62 billion in the second quarter.

Nonperforming assets were $13.3 billion, or 1.42 percent of total loans, leases and foreclosed properties. The dividend cut at Bank of America, the country's largest bank in terms of deposits, mirrors similar moves by smaller banks across the country as they look for ways to cut costs and raise capital amid the volatility that has driven some of the country's biggest financial institutions out of business.

For more on credit cards see this WSJ article.

I think the credit crisis and its impact on the economy have a long way to go. There are many reasons I believe this and I have been writing about them for the past year. What I found amazing and would like to point out is just how rapidly Wall Street greed exploded, bringing the financial system to its knees. In 2004, investment banks and commercial banks were recipients of deregulation relating to the amount of leverage, on and off their balance sheets, they could employ. There have been many reports on these events, including this New York Times article addressing the investment banking regulations, this blog piece by yours truly addressing both sets of regulations, and this one I penned last May pointing my finger at Bush appointed regulators. Two years after these regulatory changes, the system imploded. True, there are many other issues that are much longer term in nature. In particular, unregulated derivatives markets turn out, not unexpectedly nor without warning, to be a major structural problem in the financial system, and easy monetary policy plus global liquidity were certainly contributing factors. But notwithstanding these other factors that come in to play in this crisis, the simple fact is that if regulators had limited the amount of leverage financial institutions could employ we would not have necessarily reached the crisis stage.

In 2004 regulators gave Wall Street some rope, and it took a mere blink of the eye for Wall Street to hang itself (and, unfortunately, a lot of others).

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TGIF!

Today was one of the most interesting days I have ever witnessed in the markets. I am not a market expert so take all of this with a grain of salt, but it was watching history in the making.

I would say it was a really bad day like last Friday. Last Friday I wrote that it was a really bad day that did not bode well for the markets. This week certainly seemed to support that logic with the DOW having its worst week ever in its 112-year history. It was a really bad day last Friday because the credit markets were screaming with the TED Spread at historic highs and prices of everything down on the day (everything except Treasuries). Stocks, oil, and even gold fell last Friday. By that logic today was even worse.

Today the TED spread was even higher than last Friday, stocks, oil, and gold all fell again, and unlike last Friday even Treasury securities fell in price. It feels as though there is a mass liquidation going on as investors scurry to meet margin calls. Sell anything and everything – we need cash! De-leveraging is in high gear this week.

There were, however, some encouraging signs in the stock market today. After falling precipitously at the open, over 690 points down, the DOW recovered and went positive for a while in what was a stunning reversal. It then lost steam and spent the better part of the day down between approximately 250 – 500 points. At the end of the day the index made another comeback, again turning positive by over 300 points before ending down a “mere” 128 points (seems like small potatoes now). The spread between the high and low of the day, 1,018.77 points, was the largest ever in the history of the DOW. The Nasdaq ended up just ever so slightly.

Summing it up, virtually all asset classes were down today including stocks (on NYSE record volume), bonds (including Treasuries), and commodities (including gold), while the credit markets remained in shambles. This suggests the markets are in full de-leveraging mode and its sell first, ask questions later. There were, however, two remarkable intra-day rallies in the DOW and the Nasdaq ended up for the first time all week, providing a glimmer of hope. It really did seem as though bargain hunters came out in force today and scooped up stocks on the cheap when the market was under extreme pressure. Whether this is a sign that things will moderate is impossible to tell and in the end all asset classes ended down in price. It was comforting, however, to see the cash coming to the table. Even I dipped my toe in the water and I am extremely bearish. Greed got the better of me but I kept it in check by making only small purchases and putting on a hedge. Unfortunately, if nothing changes for the better over the weekend and the de-leveraging continues, next week could be another painful one. There were hopes that the G-7 Finance Ministers and Central Bank Governors would come out with a coordinated plan of action to battle the credit crisis and that may have been fueling some optimism. Unfortunately there was no plan, only a "commitment" to continue working together to stabilize the credit markets – something that has not happened yet. One thing that has happened – I have a splitting headache from following this week's gyrations. TGIF!

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More From The Federal Reserve

The Federal Reserve announced today that it will form a special purpose vehicle (the Commercial Paper Funding Facility or CPFF) that will purchase commercial paper in the marketplace from qualified issuers. This raises many questions, such as whether the Fed is now rationing credit to US companies without oversight.

The Federal Reserve is already in effect purchasing asset-backed commercial paper through its Asset-Backed Commercial Paper Money Market Liquidity Facility (ABCPMMLF) where it is lending money to banks to purchase commercial paper that is then pledged to the Federal Reserve. The twist here is that the loans to the banks are non-recourse, so if the commercial paper defaults the Federal Reserve is stuck, not the bank that borrowed the funds – same risk as ownership if you ask me. This action was authorized pursuant to section 13(3) of the Federal Reserve Act (see below). The commercial paper that banks are purchasing and pledging to the Federal Reserve under the ABCPMMLF is secured by the assets backing the asset-backed commercial paper.

The Federal Reserve is now expanding its use of this authority to purchase commercial paper directly from issuers that may be non-bank companies raising the prospect that the Federal Reserve will be rationing credit to US businesses. There is also an issue of authorization, and it seems definitions are malleable in times of crisis. From today’s announcement:

The CPFF will be structured as a credit facility to a special purpose vehicle (SPV) authorized under section 13(3) of the Federal Reserve Act. The SPV will serve as a funding backstop to facilitate the issuance of term commercial paper by eligible issuers.

According to section 13(3) of the Federal Reserve Act:

3. Discounts for Individuals, Partnerships, and Corporations In unusual and exigent circumstances, the Board of Governors of the Federal Reserve System, by the affirmative vote of not less than five members, may authorize any Federal reserve bank, during such periods as the said board may determine, at rates established in accordance with the provisions of section 14, subdivision (d), of this Act, to discount for any individual, partnership, or corporation, notes, drafts, and bills of exchange when such notes, drafts, and bills of exchange are indorsed or otherwise secured to the satisfaction of the Federal Reserve bank (emphasis added): Provided, That before discounting any such note, draft, or bill of exchange for an individual, partnership, or corporation the Federal reserve bank shall obtain evidence that such individual, partnership, or corporation is unable to secure adequate credit accommodations from other banking institutions. All such discounts for individuals, partnerships, or corporations shall be subject to such limitations, restrictions, and regulations as the Board of Governors of the Federal Reserve System may prescribe.

According to the highlighted section of the Act the commercial paper purchased by the Fed must be SECURED. My understanding of security in lending transactions is that there is a guaranty or some form of asset available to the lender that can be sold in the event of a default, the proceeds of which would be likely to repay the debt. According to the Federal Reserve's release:

Commercial paper that is not ABCP must be secured to the satisfaction of the Federal Reserve. The commercial paper may be secured in one of the following ways: (i) The issuer pays the SPV an upfront fee based on the commercial paper initially sold to the SPV and a further fee based on subsequent commercial paper sales above that amount (emphasis added); or (ii) The issuer obtains an indorsement or guarantee of the issuer’s obligations on the commercial paper sold to the SPV that is satisfactory to the Federal Reserve; or (iii) The issuer provides collateral arrangements that are satisfactory to the Federal Reserve; or (iv) The issuer otherwise provides security satisfactory to the Federal Reserve. The Federal Reserve will consult with market participants about other methods for issuers of non-ABCP commercial paper to provide satisfactory security to the Federal Reserve.

I wonder how being paid a fee for purchasing commercial paper meets the definition of SECURED under the Federal Reserve Act quoted above. It sounds more like creation of an insurance pool to me. Shouldn't the Federal Reserve obtain Congressional approval to purchase commercial paper from issuers in this manner? The authority is not clear to me.

I do not object to the Federal Reserve taking whatever action is within its authority that could help avert a financial disaster. What I do object to is when institutions bend the meaning of laws to accomplish what they want but then speak about the rule of law and the need to police the actions of those who seek to avoid compliance. Isn't this exactly how we got into this mess in the first place? I am also troubled by the fact that the Federal Reserve can now be seen as rationing credit to US corporations and that this situation is ripe for abuse through influence. There should, in my opinion, be oversight.

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Fed Goes Nuclear

The Federal Reserve is going nuclear. The TAF is doubling to $900 billion, interest will be paid on reserves beginning October 9, and the rules prohibiting commercial banks from purchasing assets from affiliated money market mutual funds is being relaxed. This last move puts FDIC insured deposits behind money market mutual funds which is, I believe, a roundabout way to get taxpayers behind the funds. They previously did this for the investment banking affiliates. The interest on reserves is required because the Fed is flooding the system with reserves and if it did not pay interest on reserves its target rate would be meaningless, as overnight lending rates would plummet to near zero. This is amazing – unfortunately - and there is likely more to come. Who thought $700 billion was a lot?

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Why It’s a Bad Day

Today was a bad day.

First, the credit markets are screaming. The TED Spread is at historic highs. If you don’t know what the TED Spread is, it measures the difference between the interest rate paid on Treasury securities and the LIBOR rate. LIBOR is the London Interbank Offer Rate, and that is the rate banks offer to lend dollar reserves to one another in London. So why is the difference between these two rates important?

Rates on Treasuries are staying way down because investors don’t know where to put their money to keep it safe, let along make a return. So they run to the safest investment they can find – Treasuries. This is called a flight to quality. On the other side, banks don’t want to lend to each other. This is in part because they are afraid they will not get paid back and in part because they are concerned their funding sources may dry up so they are hording reserves. This is a sign that the banks are very nervous. The bigger the difference between these two rates, the more fear in the markets.

The other very troubling sign is the concurrent declines in oil, stocks, gold, and other metals on the heels of an already declining housing market. Usually, when the stock market is down, you can watch the funds flowing into gold or oil or some other investments. Now, however, that’s not happening. Stocks are being sold off and the money is going out of the markets, perhaps into Treasuries and perhaps under the mattress. This could be a sign that large investors such as hedge funds are selling to raise cash for distribution to withdrawing investors or meeting margin calls. It could also be a sign that investors appear to be coming to terms with a very poor global economic outlook. In any event what we are seeing is signs of deflation. If you have any doubts about why deflation is bad, think about paying off your mortgage as the value of your house, your wages, and everything else falls except the amount you owe. Think about a business investment when the value of the product you will produce is likely to decline while the loan you use to finance the investment does not. Deflation is a really bad thing because it hurts the wealth of anyone who is a net borrower (most households) and it discourages investment leading to more unemployment. More unemployment on top of an already weak labor market can result in a downward spiral as consumption shrinks due to job losses causing more job losses causing less consumption, etc.

Warren Buffet has been in the news lately. Many have felt comforted by his investments in Goldman and GE. I have not, because it tells us that the bluest of blue chip companies are now paying 10% plus equity warrants at or around current market prices to raise capital. This is to replace short term funding from sources such as commercial paper where rates are (or were) much lower. This tells us financing is very difficult to obtain and the higher cost of funds will likely have a negative impact on future earnings.

In the long run, it shows that Buffet has faith in the United States and that's good. What happens between now and the long term is what has me concerned. One day does not a trend make, but this is not a good day.

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Policy Implications of the Credit Crisis

I have been working on a way to conceptualize where our economy is and how we got here. I am trying to avoid all of the finger pointing that is currently going on (including my own finger pointing) in an attempt to remain somewhat objective, and I do not pretend to include all of the elements of our current economic system. What I am trying to present is a basic model that helps explain the relationships between our economic system and the need for tax, trade, energy, and education policies. I want something that can work for students, and I appreciate any suggestions that would improve the model and/or the presentation.

I have developed a framework that I think makes sense and it is represented by the two diagrams below. The first diagram, "The Way It Was", illustrates the basic wealth creation model of a country with balanced internal flows and net exports. This is the USA in the past. Note that there are net positive flows to investors from within the USA and from abroad (represented by blue items), while at the same time there are positive flows to the USA box, representing domestic wages and consumption (the red lines) from domestic investment and net flows from abroad. The INVESTMENTS box is subdivided into investments in productive assets and investments for consumption. I have labeled the consumption investments FINANCIAL to represent purchases of financial assets supporting consumption such as consumer loans, mortgage backed securities and so forth.

The next diagram represents "The Way It Is". Note the change in flows of investment in production from the USA to Non-USA recipients of investment represented by the red line. This creates a shift in the net wage gains and net consumption flows as we begin to import more from overseas production and invest less domestically than we otherwise would. Initially this model works well for investors as profits increase due to cost reductions. Adding tax cuts into the mix provides a dramatic increase in wealth to investors and a larger pool of investment capital. Adding to that profits from the gains made by NON-USA investors investing back into the USA and you have a gigantic pool of liquidity looking for profitable investments. Unfortunately, at the same time this massive liquidity pool is building, the reversal of flows to wage earners begins to put pressure on consumption. This should have caused a reduction in consumption in the USA that would have been a normal response to these changes in flows, but it did not. Rather than adjusting production down to a new level of consumption the massive liquidity pool was directed into financial instrument supporting consumption. This created the base for a large explosion in debt as USA consumers continued to consume financing this over-consumption through debt. Now, however, consumption is above the wage earners' means of supporting ownership and the debt underlying the financial instruments invested in by investors begins to go bad (defaults on home mortgages, for example).

Combining all of these factors we get both a debt bubble (represented by the green lines) and a wealth bubble (represented by the blue lines). This is where we are today, and the bubbles are unwinding. Wealth is falling as asset values decline and the debt bubble burst last year. We are currently on life support from the Federal Reserve and other government sources. At this time we should see a reversal of consumption flows as USA consumers pull back. This would help to slow the imbalance of international flows through a normal adjustment process (including a falling dollar as USA interest rates fall and the economy weakens). Unfortunately this is where energy policy (or lack thereof) comes in. As investors try to protect their asset values they are moving from financial investments to hard assets such as gold and energy products. Energy products are also priced globally in dollars, so as the dollar declines in value the dollar price of energy goes up. These factors are keeping energy prices high, and since the USA is a massive importer of energy the trade flows remain strongly negative.

So, what does all of this tell us with respect to our national policies? I believe it has implications for tax policy as tax incentives to the investor class may have over stimulated the economy during globalization. I pose the unanswerable question – would real interest rates have been negative for so long in 2003 if tax cuts flowed to consumers rather than investors (thereby stimulating consumption rather than "investment")? Would the size of the debt bubble have grown so large if there were less investment chasing return? Questions that merit empirical study, I think. Perhaps tax cuts for wage earners would be better policy considering all of the money flows.

It also has implications for trade policy as sustaining the structural trade flows we currently have is a recipe for massive wealth transfer from the USA to energy producing countries (this massive transfer is currently under way). That brings us to energy policy. Perhaps we should direct future investment into energy independence. This is not a new idea, but this model helps to illustrate the need and the interdependence of energy, trade, and tax policies. Developing new sources of energy could certainly help reverse the flows back to what they were in the first diagram. I'm not suggesting we adopt an isolationist stance. What I am suggesting is that we very quickly direct our investment capacity in a massive way into energy independence and additional efficiency technologies to help offset the advantages of investing outside the USA (rather than simply driving USA wages down). You can bet that other countries are doing exactly that and we are in direct competition with them. This, then, gets us to education. Should it be a national priority that we educate the population to the maximum of our capacity? I believe it is.

What has been missing, in my humble opinion, is leadership to help guide the country through appropriate policy incentives to achieving these necessary goals. This void has left us scarred and my hope is that the current crisis will point us in the correct direction for the long term. (OK, I couldn't help just a bit of politics).

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What the Plan Does (and does not)

Now that it appears Congress will pass the bailout plan the next logical question is “what’s next?” I don’t know the answer, but I have my concerns.

This plan may well deal with the current stresses in the financial markets. If so, we can all stop panicking that the world as we know it will come to an abrupt end and get back to the real economy. But, as one commentator just said on CNBC, this may put the fire out but the furniture is still burned. The problem is that the real economy isn’t doing too well. Unemployment is up, spending is down, people are concerned, so where are we headed from here? First, lets see what the current plan hopes to accomplish.

Here is the problem. If a bank has lots of bad assets on its balance sheet, it can’t sell them because if it does it takes a loss on the sale. That loss reduces the bank’s capital, and without adequate capital a bank cannot make loans. On the other hand, if the bank just holds on to the bad assets, it can’t raise new cash to make loans because no one wants to lend it money without knowing how bad the bank’s balance sheet actually is. So as long as these bad assets are being held by the banks lending activity slows or, in the worst case, stops all together. If this gets really out of hand and these bad assets start showing up in other places (like money market mutual funds) then investors start taking their money out of all the places they invest and all lending could stop. That would be the modern day equivalent of a run-on-the-banks. No loans, no economic activity and we fall into a very bad economic shutdown. The only difference between this kind of bank run and the classic depression era run is that the taxpayers stand behind the deposits in commercial banks today through the FDIC and Treasury so we collectively insure our deposits. This prevents a run on commercial banks. We don’t, however, insure the funding sources for all of the other financial institutions in our financial system. Money market mutual funds, insurance companies, investment banks, hedge funds, and private equity raise funds that are not insured against loss. When these bad assets start showing up in those places the sources funding them run. This is why the federal government announced an insurance plan for money market mutual funds last week, and is also why we have witnessed the demise of the independent investment banks. The investors in these banks have stopped funding them – a run on the investment banks. So, although commercial bank deposits that most Americans have in their bank are insured, there is an entire system of finance that doesn’t have this protection and is prone to a classic run. That run is in progress. The current plan hopes to remove bad assets from balance sheets of financial institutions so that lending will return to the economy and investors will stop running. It is intended to “unplug” the flow of money throughout the system by taking away the source of the clog – these bad assets. But even if it works, where do we end up?

A while back I posted an article that explained how the level of household debt to personal income has grown too high and until consumers pay down their debts to a level they can afford the economy will not do well. This is parallel to what is happening in the housing market. Until prices return to a level that makes purchasing a home affordable for the average homeowner prices will decline. As far as overall household debt is concerned, until it returns to a level supportable by personal incomes debt must be reduced. How do we reduce debt? We save rather than spend. Saving more and spending less means less economic activity, and that means a possible recession. So how does the rescue plan deal with this issue? I don’t think it does because it doesn’t deal with the bottom up issue that consumers are in too much debt. How much debt are US consumers in? Total household debt is about $14 trillion, or approximately 145% of 2007 annual disposable personal income. What was this ratio the last time we went into a banking crisis in, say, 1991? It was approximately 85%. That leads us to a thought experiment. What would it take to get us back to the levels of debt to income that we had during the last crisis? If we assume disposable personal income will grow by 2% for this year, then personal income for 2008 should be approximately $9.8 trillion dollars. At 85%, household debt would be approximately $8.4 trillion. Since actual household debt is currently in the $14 trillion range, we need to de-leverage about $5.6 trillion to get back to the 85% ratio we had in 1991. In a $14 trillion economy that represents about 40% of one year’s GDP. In fact, it’s even worse than that because if we stop borrowing in order to save then we also lose the GDP funded by debt (another $880 billion). Comparing other developed countries that have seen similar increases in household debt to disposable personal income, Japan stands out as it went over 120% in – you guessed it, 1991 (see page 47). This was the start of the “lost decade” for Japan.

I don’t expect we would make up all 40% of our adjustment back to 1991 in a short period of time, nor am I convinced that we will ever actually get there without a major new boom in real economic activity (such as discoveries relating to new energy technologies) or a major bust where debt gets written down in mass quantities. The situation does, however, point us to what we can expect next. Expect a rather protracted recession and/or more government interventions into the economy before this is over. I expect the next intervention will be of the bottom up sort, and eventually if the Federal Government owns enough mortgages I can see debt forgiveness of underlying mortgages owned by taxpayers.

Debt numbers: here
Personal Income numbers: here.

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Goldman Profits Up on Short Sales of Goldman

OK, the headline is completely fictional, I think. I just re-read some articles about how Goldman Sachs was at the heart of creating so many toxic mortgage securities and how watching its former head (Treasury Secretary Paulson) pining for $700 billion of taxpayer money to clean up the mess is disgraceful. One of the points that came out again was the fact the Goldman came away from the whole mortgage crisis relatively unscathed from a profit point of view because it was shorting that market heavily as the crisis unfolded. Now, of course, regulators have prohibited short sales in Goldman stock to prevent Goldman's stock from collapsing and there is a witch hunt going on to find those evil short sellers. Wouldn't it be an absolute riot if it turns out Goldman was one of them?

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