USA is heading toward an economic collapse. Day of reckoning in the US glasshouse

[unsoberx]

From The Times. January 21, 2008

Day of reckoning in the US glasshouse

http://business.timesonline.co.uk/to...cle3220961.ece

World Economic Forum: The Davos Agenda

Jospeh Stiglitz

There is a growing consensus: America is going into a marked slowdown, if not a downright recession. There will be a large gap between potential growth ? usually estimated at 3 per cent to 4 per cent ? and actual growth, meaning lost output of hundreds of billions of dollars. America actually faces three separate but related problems; a credit crunch, a debt crisis and a macro-economic problem.

A decade ago, America roundly criticised the countries of East Asia for their lack of transparency and inadequate regulation. But, as the old aphorism goes, people in glass houses shouldn?t throw stones. Money was lent to hundreds of thousands of Americans beyond their ability to pay. What was called financial innovation meant that borrowers didn?t even have to pay the accrued interest; at the end of the year, they owed more than at the beginning. Liar mortgages had been invented, requiring no evidence of income or ability to pay.

Borrowers were told not to worry about their mounting debt. With prices going up year after year, the more they borrowed, the more they made. What was true was the more they borrowed, the more the mortgage brokers and the banks made. It was, in a sense, an old-fashioned pyramid scheme: prices simply couldn?t go on rising, especially as the real income of most Americans was actually declining. Low interest rates fed the bubble, but that was not enough: the Chairman of the Fed actually encouraged people to take out variable rate mortgages (where payments would go up as interest rates increased), just when interest rates were at an all-time low. They had only one way to go, and that was up.

Then these ?toxic mortgages? were sliced and diced, bundled and rebundled, in complex securities. The bankers seemed, for a moment at least, to believe in financial alchemy. Take a bad mortgage, blend it with an A-rated security and the mix got an A rating from the credit agency.

What, one has to ask, were they thinking? They were trying to defy the laws of economics: how could individuals pay more on their mortgages than their income? I, and others, repeatedly pointed out that this simply could not go on. A day of reckoning had to come; it has now arrived.

For the Fed and the Bush Administration, the answer to what they were thinking is easy: they needed the profligate borrowing to keep the economy going, even with Bush?s huge deficit spending. The game was called ?kick the ball down the road?.

The hope was that, somehow, the real estate bubble would not blow up during their watch and that somehow the others could be postponed, too. The war had driven up the price of oil, so more of America?s income was going to Saudi Arabia and other oil producers, and less on American goods. The war expenditures themselves stimulated the economy far less than money spent on, say, the infrastructure (such as New Orleans?s levees).

The Bush tax cuts for the rich provided little stimulation. The toxic mortgages and the housing bubble allowed Americans to consume 100 per cent of their income and savings dropped to zero for the first time since the Great Depression.

The game is up. Even if the Fed were to lower interest rates, banks will not be willing to lend and households will not be willing to borrow in the manner they did before. House prices are falling ? in some parts of the country, they are plummeting. Some experts are predicting a pricing correction of 50 per cent or more.

It was all fed, of course, by securitisation ? the notion that somehow by bundling bad mortgages together you get a good product. But the new religion of securitisation ignored two elementary realities.

First, diversification only works to reduce risk if risks are not correlated, but, when housing prices start to fall, all of the sub-prime mortgages turned sour together. Second, securitisation creates asymmetries of information, where those buying the securities know less than those originating them. In the old days, when banks held the mortgages they originated, they had an incentive to make sure that they were good loans.

But with securitisation, if you could find enough fools to take bad mortgages, you had every incentive to lend as much as you could. What is remarkable is how many fools (including banks with supposedly good risk management systems) there were. That game, too, is up, at least for the duration.

Let?s be clear: this is not just an ordinary economic downturn, an inventory cycle where firms have accumulated excess inventories. In this case, banks have suffered a major hit to their balance sheet and, given the lack of transparency, we don?t yet know how big a hit. But we know there is some missing matter: with more than two million anticipated foreclosures, the losses are likely to run to much more than the banks have announced so far.

Moreover, there is a vicious circle: foreclosures drive down housing prices, leading to more foreclosures. And as individuals find it increasingly difficult to make mortgage payments (as interest rates get ?reset? automatically at higher rates, a built-in feature in millions of these mortgages) and as the economy slows down, the problems will spread to other credit markets. Indeed, this is already happening.

It is likely that America?s zero savings will return to a more normal level, 5 per cent or so. This will exert an enormous drag on the economy. If it happens rapidly, the downturn will be sharp; if it happens more slowly, the downturn will be prolonged. Investment in real estate, too, will be depressed for years to come. Other investment is not likely to increase sufficiently to offset, especially with banks restoring higher lending standards.

America has already exported some of its problems: banks around the world bought its toxic mortgages; globalisation has meant that rising risk premiums and the credit squeeze have had global consequences. For good reason, confidence in America and its currency have declined; but this makes it more difficult for Europeans to export, easier for imports to compete. The exchange rate adjustments and the resulting reduction in America?s imports will temper its downturn but will not be sufficient to offset weak consumption and investment.

Even the Fed is beginning to realise that, although misguided monetary policy and inadequate financial regulation got the US into the mess, reversing course will not get it out. (In a classic case of shutting the barn door after the cows are out, regulations have now been tightened. It has admitted, in effect, that it was asleep at the wheel.)

Can fiscal policy do the trick? President Bush?s cureall for any of the nation?s ills ? making the 2001 and 2003 tax cuts permanent ? will drive up the deficit but not the economy. In some sense, they are at the root of the problems that have ensued. Tax rebates for lower-income Americans will have the biggest stimulant per dollar of deficit (in the jargon, the biggest bang for the buck). And it will be fast-acting.

But will the Bush Administration, so long focused on helping the rich, be willing to change course? And is it wise to encourage America on its consumption binge? What America desperately needs is more investment, in infrastructure, in research, in education. This, too, would provide a big bang for the buck. But while defence spending has soared, including billions for weapons that don?t work against enemies that don?t exist, will it be willing to countenance more government spending in these areas?

This is an election year and anything is possible. My betting is that the Administration won?t want to admit just how bad the economy is, and that even if a compromise is achieved, it will be too little too late.



Joseph Stiglitz is University Professor at Columbia University. He was chairman of the US Council of Economic Advisers and Cabinet member in the Clinton Administration. A former chief economist of the World Bank, 1997-2000, he won the Nobel Prize for Economics for his work in information asymmetries and is author of three global bestsellers; Globalization and its Discontents, Making Globalization Work and The Roaring Nineties. His latest, with Linda Bilmes, of Harvard, is on the mounting costs of the Iraq war. It is published in late February, in commemoration of the fifth anniversary of the war, by Penguin/Allan Lane.




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[5x10]

its scary
i have given the thought of stocking up on food, water, fuel, weapons, ammo, etc

if some of the big banks start defaulting, we are in serious trouble
but it will also be a worldwide problem
hundred of billions of mortgage backed bonds were sold to foreign banks, making them just as suspectable to the downturn

[Ibanez]

<100 years and American is toast. Better hope you have dual citizenship to somewhere.

[Streetbull]

Such banking allows banks to loan up to 9 times a deposit. For ex, a $1000 deposit allows for $9000 in loans. The bank gets free interest on the $8000 it created. The trouble is that this multiplier works in reverse just as well --- if more than $1000 goes into default, it begins to eat into the bank's capital.

No country that ever allowed fractional reserve banking avoided cycles of speculation and depression. Now combine that with the dollar being the world's reserve currency...

Stock up on food and ammo...lots of ammo...there'll be a lot of hungry people.

[5x10]

Stock up on food and ammo...lots of ammo...there'll be a lot of hungry people.

once u kill em, will u eat em?

[dr_D]

economic collapse? Please do not exaggerate. No where in the article does Stiglitz say that he predicts an economic collapse -just a possibility of a contraction.

Stock up on guns, canned food, ammo....

yes, because with every recession comes anarchy and the fall of capitalism, only to be restored when the economy starts expanding again

[5x10]

yes, because with every recession comes anarchy and the fall of capitalism only to be restored when the economy starts expanding again

a recession is not what im worried about, its a depression

its when a couple of huge banks fail, then the FDIC is supposed to ensure all of that money(which they cant), run on the banks, dollars worthless, blah blah blah

i hope it doesnt happen

[Streetbull]

once u kill em, will u eat em?

In the 'nam, I got seperated and cut off after a firefight. Couldn't find anyone and everyone with me was dead. Took me 4 days to get out. I found these roaches, biggest damnned roaches I've ever seen.

You'd be surprised what men will eat if they get hungry enough.

[dr_D]

a recession is not what im worried about, its a depression

its when a couple of huge banks fail, then the FDIC is supposed to ensure all of that money(which they cant), run on the banks, dollars worthless, blah blah blah

i hope it doesnt happen

some of the very large banks (mainly investment banks, not to sure about depository banks) have been recapitalized by foreign sovereign wealth funds, although how this would affect the credit crunch is a wait and see.

[JUSA]

I hope it's not that severe.

I do take exception to the article where it calls the Bush tax cuts "tax cuts for the rich". Time and time again, that's been shown to be bull**** and the only people I hear who term them that way tend not to know anything or have an agenda.

A percentage cut is going to benefit the guy paying a greater percentage. If that's the rich guy, he's only benefiting because he's paying a far greater amount than the poor guy already.

[ironman1964bc]

Just wait until tomorrow......it ain't gonna be pretty.

[Spetsnazos]

I worked at Countrywide for 2 years as a Loan Underwriter. I knew that 80% of the stated loans and payoption(the 1% teaser rates) were a joke. I told all my friends/family not to get them. I told everyone that this wasnt going to work and people are going to default in mass once the rate goes up.

I approved tons of loans because of the idea, "prices are only going up".

I laugh now, because it was so obvious to spot if you are a borrower or a professional working in the industry...

[dr_D]

I hope it's not that severe.

I do take exception to the article where it calls the Bush tax cuts "tax cuts for the rich". Time and time again, that's been shown to be bull**** and the only people I hear who term them that way tend not to know anything or have an agenda.

A percentage cut is going to benefit the guy paying a greater percentage. If that's the rich guy, he's only benefiting because he's paying a far greater amount than the poor guy already.

well poor households also have a higher marginal propensity to consume because they have less income to buy the same amount of goods than the richer has. Even if the household with higher income does pay more taxes, they will still have a higher amount of disposable income than the poorer household.

Besides Reaganomics (Bush's policies) have been proven not to work.

I have a lot of respect for Joseph Stiglitz. He is very pragmatic in his analysis.

[badbart]

Every 5 years or so its recession followed by expansion. The economic cycle has been going on since the beginning of the USA. Nothing new nothing to worry about. The media just has to make some hype with super exaggerated theory. You guys have never seen a real recession, the 70's and early 80's make the 92-93 and 01-02 recession seem like child's play. I think this recession will be much shorter then the last recession. 5 or so years later you will reading the same crap about the world collapsing because of the normal economic cycle repeating its self.

[JUSA]

well poor households also have a higher marginal propensity to consume because they have less income to buy the same amount of goods than the richer has. Even if the household with higher income does pay more taxes, they will still have a higher amount of disposable income than the poorer household.

Besides Reaganomics (Bush's policies) have been proven not to work.

I have a lot of respect for Joseph Stiglitz. He is very pragmatic in his analysis.

Yea, I know. People who makes more money *gasp* should take home more money... just because they make more, they shouldn't have more stolen from them from the Government.

If I bush my ass my entire life in school and make good grades, work my way through college and graduate with a 3.8GPA, get a good paying job, work hard at it (show up on time, work late, work hard, etc..) and get promoted over the years I f*cking well make more than some loser who barely graduated from High school, if at all, is lazy and works a ****ty job that requires no skill or education.

I shouldn't be punished and taxed higher because I can afford to pay more. F*ck that.

[Spetsnazos]

Every 5 years or so its recession followed by expansion. The economic cycle has been going on since the beginning of the USA. Nothing new nothing to worry about. The media just has to make some hype with super exaggerated theory. You guys have never seen a real recession, the 70's and early 80's make the 92-93 and 01-02 recession seem like child's play. I think this recession will be much shorter then the last recession. 5 or so years later you will reading the same crap about the world collapsing because of the normal economic cycle repeating its self.

no offense but if we all had the idea that "everything is going to be alright"...
well, one day it wont be alright and we'll all point the finger and ask, "why didn't we do something to stop it"?

Also the way tax cuts to the rich work is based on an economic principle of trickle down effect. The rich now have more money from tax cuts, thus they give more money to their employees(salaries), then those employees go and spend the money thus improving the economy. I dont know how it works, but on paper it looks fantastic! lol

[badbart]

no offense but if we all had the idea that "everything is going to be alright"...
well, one day it wont be alright and we'll all point the finger and ask, "why didn't we do something to stop it"?

Also the way tax cuts to the rich work is based on an economic principle of trickle down effect. The rich now have more money from tax cuts, thus they give more money to their employees(salaries), then those employees go and spend the money thus improving the economy. I dont know how it works, but on paper it looks fantastic! lol

Tax cuts would help and lower interest rates. But theirs nothing you can do to stop it, next time it will be another unforeseen even triggering a recession.

[Spetsnazos]

Just wait until tomorrow......it ain't gonna be pretty.

whats tomorrow, excuse my ignorance

[Mauler97]

Who ever wrote that needs a spell-checker.

The sky is not falling!

[badbart]

whats tomorrow, excuse my ignorance

The futures and overseas markets are getting hammered.

[dr_D]

Every 5 years or so its recession followed by expansion. The economic cycle has been going on since the beginning of the USA. Nothing new nothing to worry about. The media just has to make some hype with super exaggerated theory. You guys have never seen a real recession, the 70's and early 80's make the 92-93 and 01-02 recession seem like child's play. I think this recession will be much shorter then the last recession. 5 or so years later you will reading the same crap about the world collapsing because of the normal economic cycle repeating its self.

since the 1970s the average recession has lasted less than a year (10-11 months)

although this one is a bit different, as Stiglitz points out, that this one is attributable to the crisis in the financial sector and the subsequent credit crunch. The only modern precedent is the Japanese one in the early 90s which turned out to be quite severe and prolonged. Taking an uneducated guess, I would say that simply because the U.S economy is so dynamic that it could avoid at least a prolonged downturn.

[badbart]

Who ever wrote that needs a spell-checker.

The sky is not falling!

right markets typically overreact on the down side and up side. All you worry warts sell your stocks to me and well see who's wins in 10 years.

[Spetsnazos]

The futures and overseas markets are getting hammered.

havent they been getting the hammer for the last 3 quarters with our volatile market?

I am just curious as to what tomorrow might bring thats any different

[badbart]

since the 1970s the average recession has lasted less than a year (10-11 months)

although this one is a bit different, as Stiglitz points out, that this one is attributable to the crisis in the financial sector and the subsequent credit crunch. The only modern precedent is the Japanese one in the early 90s which turned out to be quite severe and prolonged. Taking an uneducated guess, I would say that simply because the U.S economy is so dynamic that it could avoid at least a prolonged downturn.

I agree, I think this will be much less severe then 2001-2002.

[badbart]

havent they been getting the hammer for the last 3 quarters with our volatile market?

I am just curious as to what tomorrow might bring thats any different

Sure but I've been in the market sine the late 1980's, i bought a few stocks as a child. Staying invested through the ups and downs have brought huge profits. Since 1993 I have tracked my investment with quicken and I have increased my investments 19 fold.

[IraHays]

Couple things.

Tax cuts were for everyone, why do these people always say "for the rich"?

Retirement savings, like 401K are not inlcuded in the personal savings %.

But still, we are going into recession, and we need one.

[badbart]

But still, we are going into recession, and we need one.

I have to agree with you on this, its better the bubble burst now then in 3 years and have a much worse problem.

[Spetsnazos]

But what is happening specifically tomorrow thats any different??

[badbart]

But what is happening specifically tomorrow thats any different??

Today the European stock markets are selling off, but Wall Street is closed for MLK day so maybe we will see a big sell off tomorrow on wall street.

[Spetsnazos]

Today the European stock markets are selling off, but Wall Street is closed for MLK day so maybe we will see a big sell off tomorrow on wall street.

awesome thanks!!!
rep'ed