30-year bond at 3.3%

[Extra Stout]

Liquidity trap. The Fed is now powerless to do anything to stop the fall into extended depression.

Americans have no savings, massive debt, vanishing credit, monetary policy is already at the end of its rope, and we haven't even started the worst part yet.

The only thing left to try is good ol' Keynesian government fiscal stimulus on a massive scale, and just hope the U.S. can borrow enough money to do it.

You probably look around you and think, "What is ES babbling about? Things don't look so bad around here."

By March you will understand.

[clambake]

no doubt. the shit storm is coming. unemployment is gonna explode.

[2centsworth]

Liquidity trap. The Fed is now powerless to do anything to stop the fall into extended depression.

Americans have no savings, massive debt, vanishing credit, monetary policy is already at the end of its rope, and we haven't even started the worst part yet.

The only thing left to try is good ol' Keynesian government fiscal stimulus on a massive scale, and just hope the U.S. can borrow enough money to do it.

You probably look around you and think, "What is ES babbling about? Things don't look so bad around here."

By March you will understand.

don't underestimate people's resiliance to survive. No matter how much people make, they always find a way to survive. Prices will come down to reflect such a change. Massive deleveraging is what we need as a country. Painful though.

[Viva Las Espuelas]

weimar republic?

[Spurminator]

don't underestimate people's resiliance to survive. No matter how much people make, they always find a way to survive. Prices will come down to reflect such a change. Massive deleveraging is what we need as a country. Painful though.


I guess the question will be whether the average person's earnings drop more or less than the cost of the unnecessary crap he pays for.

[Extra Stout]

don't underestimate people's resiliance to survive. No matter how much people make, they always find a way to survive. Prices will come down to reflect such a change. Massive deleveraging is what we need as a country. Painful though.
True. People who live in the favelas in Brazil figure out a way to survive and Americans will too.

[Anti.Hero]

Been ready for this shit years ago.


Fuck debt.

[Cry Havoc]

Liquidity trap. The Fed is now powerless to do anything to stop the fall into extended depression.

Americans have no savings, massive debt, vanishing credit, monetary policy is already at the end of its rope, and we haven't even started the worst part yet.

The only thing left to try is good ol' Keynesian government fiscal stimulus on a massive scale, and just hope the U.S. can borrow enough money to do it.

You probably look around you and think, "What is ES babbling about? Things don't look so bad around here."

By March you will understand.

Things look bad and worse. Anyone with even a loose grasp on the economy can see that things are going DOWNHILL, not that the storm has passed and we'll improve from here on out.

This is what happens when you have a combination of material greed and companies who are willing to openly take advantage of and exploit the middle-class person. CEOs make billions of dollars per year, sit on federally approved company board with the executive power to make it's own policies, including giving failed board members who don't do their jobs millions of dollars in severance. And then the company goes bankrupt. Shocker!

There is absolutely nothing positive that you can gather from this, except perhaps in the end it will change American business for the better. It's going to be a long, painful economic struggle. And people aren't going to realize how deep it goes until they line up outside their local Safeway/Jewel/Trader Joe's/Aldi's to buy food and find the doors locked. It sounds ridiculous until you look at the last time this happened, and then realize that we are much more dependent upon store bought goods and services now than ever before.

Growing up in this generation, I thought the events that I would tell my kids about would be first, 9/11. Then, the Indian-Ocean Earthquake and Tsunami of 2004. And maybe Katrina. I'm sure those will have mention, but they have the potential to be overshadowed, at least in America, by the coming economic devastation. And we're right on the brink as it is. And I'm hoping that this situation isn't overtaken by the events in Iran and Pakistan. Scary.

[boutons_]

I read an article that govt stimulus after WWII went into real stuff, infrastructure, etc, investments that paid back for decades.

Now govt stimulus is going into paper, contracts, debts, propping up financial sector which is mostly a house of cards. iow, little or no payback for the $Ts being spent.

I read the estimate for next year's stimulus should be $1T or more, just to get the economy out of contraction and back to zero, not to get growth.

[Extra Stout]

I read an article that govt stimulus after WWII went into real stuff, infrastructure, etc, investments that paid back for decades.

Now govt stimulus is going into paper, contracts, debts, propping up financial sector which is mostly a house of cards. iow, little or no payback for the $Ts being spent.

I read the estimate for next year's stimulus should be $1T or more, just to get the economy out of contraction and back to zero, not to get growth.
The problem is that if the financial system is really just a house of cards that can't be fixed, then trying to drive the rest of the economy to recovery is like trying to drive a car with a blown engine.

[Warlord23]

The only thing left to try is good ol' Keynesian government fiscal stimulus on a massive scale, and just hope the U.S. can borrow enough money to do it.


The problem with the Keynesian fiscal stimulus is that there is no guarantee that it will even make a dent. During the 1990s, after their asset-price bubble collapsed, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen. These didn't have any effect for a whole decade - the economy finally started recovering in 2003 after trying what Paul Krugman calls "quantitative easing" (where the central bank buys more government bonds than would be required to set the interest rate to zero).

Of course, this put the Japanese government in a deep debt hole, with public debt adding up to 170% of the GDP.

It'll be interesting to see what the new administration wants to do with this mess.

[Warlord23]

I read an article that govt stimulus after WWII went into real stuff, infrastructure, etc, investments that paid back for decades.

Now govt stimulus is going into paper, contracts, debts, propping up financial sector which is mostly a house of cards. iow, little or no payback for the $Ts being spent.

I read the estimate for next year's stimulus should be $1T or more, just to get the economy out of contraction and back to zero, not to get growth.

Bingo. Stimulating the economy through financial institutions is like trying to fill a bottomless hole. If at all a stimulus is needed, it has to be into infrastructure and other government programs.

Of course, there is a school of thought which argues that the boom-bust cycle is unavoidable, and that any government intervention will just delay or prolong the severity of bust. The bust, per this theory, is a process of cleaning house and dissolving all the bad assets that the boom had created.

[johnsmith]

I'm going to dump my 401k and buy lottery tickets. I'll be sure to take the cash option so that when the lottery comission goes bankrupt I'll already have the money.


After that, I'm pretty much just going to sit back and be pissed at the new administration for taking so much extra taxes out of my winnings and then work part time at a golf course so I can get free rounds.

[xrayzebra]

Liquidity trap. The Fed is now powerless to do anything to stop the fall into extended depression.

Americans have no savings, massive debt, vanishing credit, monetary policy is already at the end of its rope, and we haven't even started the worst part yet.

The only thing left to try is good ol' Keynesian government fiscal stimulus on a massive scale, and just hope the U.S. can borrow enough money to do it.

You probably look around you and think, "What is ES babbling about? Things don't look so bad around here."

By March you will understand.

ES, not trying to pick a fight. But why March? Would you attempt
to explain why things are going to hell in a hand basket?

Like you say, I look around and I haven't really seen what all the
hype is about. I know the market is in a nose dive again today, but
it recovered some last week. People are spending.

I would honestly like to know how you come to your conclusion.

[Wild Cobra]

ES, not trying to pick a fight. But why March?

I have no idea why he thinks March, but it is the time when quite a few sales drop as people prepare to pay Uncle Sam.

[Drachen]

When you say "market" what are you looking at? If you are talking about the Dow Jones, NASDAQ, et al then you are talking about a market indicator, not an economic one. The economy is what we are talking about here. Economic indicators include unemployment, real wage growth, gdp growth, etc. All of these indicators have been bad to VERY bad with even worse predictions in the future. Market indicators only indicate human emotions, Economic indicators indicate facts.

As far as "why March" I would think he just grasped at a month when everyone is able to see all the numbers as far as the holiday season. Or maybe it was just an out and out guess. Though it doesn't seem to be ES's style to just guess, so I will just wait for his explanation.

[Winehole23]

The problem with the Keynesian fiscal stimulus is that there is no guarantee that it will even make a dent. During the 1990s, after their asset-price bubble collapsed, Japan tried 10 fiscal stimulus packages totaling more than 100 trillion yen. These didn't have any effect for a whole decade - the economy finally started recovering in 2003 after trying what Paul Krugman calls "quantitative easing" (where the central bank buys more government bonds than would be required to set the interest rate to zero).According to the pointy heads over at the RGE monitor, QE and monetization of debt are already occurring, before any Keynesian stimulus. An L-shaped recession is looking more and more likely. A decade of stagnation a la Japan in the 1990's would be a good result for us IMO.


Of course, this put the Japanese government in a deep debt hole, with public debt adding up to 170% of the GDP.Our public debt/GDP ratio stands around 360% today. It's gonna get a lot deeper, soon.

Liquidity trap, debt deflation and default. The medicine is all inflationary. Let's hope it works. If the government gets the timing or size of inflation targeting measures wrong, hyperinflation and monetary collapse may be waiting for us on the other end of the recession.

[Extra Stout]

ES, not trying to pick a fight. But why March? Would you attempt
to explain why things are going to hell in a hand basket?

Like you say, I look around and I haven't really seen what all the
hype is about. I know the market is in a nose dive again today, but
it recovered some last week. People are spending.

I would honestly like to know how you come to your conclusion.
This gets complicated and long.

The U.S. economy technically has been in recession for a year, and unemployment is usually a lagging indicator. That means that people don't start losing their jobs en masse until the economy has been bad for a while.

Usually, recessions are short, and by the time unemployment peaks, the economy has already started recovering.

Not this time.

The United States has been in a bubble economy for six years. There has been essentially no real economic growth under the Bush Presidency. Due to a stagnation and decline in wages for all but the top few percent of Americans, there is not enough income to stimulate real growth. This was made up temporarily by the development of credit, real estate, and financial bubbles.

The credit bubble was simply easy credit with low interest rates that allowed people to borrow large amounts of money to fuel their consumption (think credit cards). The real estate bubble was a credit bubble applied to real estate, that allowed people to secure mortgages for values far exceeding what they could have secured in previous years. The financial bubble was the deregulation of derivatives that basically allowed investors to "bet" on debts like mortgages, so that the money riding on debts was many, many multiples the value of the debt itself.

The reason banks gave these bad loans out is that they convinced themselves real estate prices would never go down again -- they ignored reality.

As home values increased during the bubble, homeowners were allowed to borrow against those increased values, and they poured that money into consumption. But those increased home values were not sustainable, and once the bubble popped and prices fell, their debt was unsecured. Even if they were to lose their homes, the bank still could never get all its money back.

The derivative bubble is really the death blow to the economy. There were hundreds of billions of dollars of bad mortgages given to people who couldn't afford them, but that alone could not kill the economy. There were tens of billions of dollars of bad home equity after the bubble popped. These could not kill the economy. But the derivatives against these loans are in the quadrillions of dollars, i.e. thousands of trillions. This is several hundred times the size of the entire U.S. economy.

How could this be? Well, as these markets became deregulated, Wall Street came up with ever more complex financial instruments for packaging together securities and derivatives. Take the subprime mortgages, for example, which were the bad loans given to bad credit risks where the bank was counting on a foreclosure so it could get the house back after it had appreciated in price (except the price collapsed instead). These are very risky loans, and if you were to assemble a security based upon them, a buyer would demand a very high interest rate on it, since it is a "junk bond," so the issuer of those mortgages would not get paid much for selling off a bunch of bad mortgages. But what these firms did is set up a complex hierarchy of securities based upon these bad mortgages. The first set would be like "preferred stock," that is, if anything happened, whoever held them would be first in line to get paid. Then the second set would pay off, then the third set, and so forth. The trick is that the first set would get a very high bond rating, like AA/AAA, so those firms could package up bad loans, basically launder them into high-grade bonds, and get a very high price for them.

The problem was that once real estate prices fell, all those bonds, regardless of rating, were utterly worthless.

And since they were high-rated bonds, big banks and pension funds had snapped them up, and were left holding the bag.

But even that would not have been enough to kill the economy.

No, the Wall Street guys had to come up with yet another layer of derivatives, called credit default swaps. Once upon a time, these were like insurance against bad debts. You, the creditor, would pay a third party for a CDS, and if your debtor defaulted, the third party would pay you some sum of money. Then they were deregulated early this decade, so that anybody could get a CDS on any loan, regardless of whether they were a party to it. This sparked a free-for-all of investors making bets back and forth on whether a particular debtor would pay back his debts. Then there would be on CDS's on CDS's. This escalated to the point where there are now quadrillions of dollars of outstanding CDS's, and a relatively small default, like on a subprime mortgage, for example, can result in billions of dollars of losses.

And the banks and institutions are so deeply wrapped up in CDS's, that for any given default, billions of dollars change hands back and forth, and they have no idea who is solvent and who isn't anymore. So, they are deathly afraid to lend to anybody that is even remotely a risk, even fellow banks, much money. Banks that were too heavily tied to bad mortgages and bad credit default swaps quickly went under, and their bankruptcies trigger other defaults that threaten to put other banks under the next day.

In order to have a prayer of surviving, the leftover banks need to increase their cash reserves, and that means they stop lending. But since we've gotten to the point where nobody has any savings anymore, and the whole consumption-based economy was based on shaky credit, it's like Wiley E. Coyote running off the cliff.

Or, it's an eerie reprisal of what happened to the economy in 1929. After the stock market crashed, people didn't end up in soup lines the next day. It was well into 1930 before suffering hit ordinary folks.

So credit is drying up like the Mojave Desert, and we're tumbling headlong towards another Great Depression. The federal government has desperately been trying to stem the tide by throwing hundreds of billions of dollars at banks to buy their bad loans. That didn't work. So they stopped that and instead threw hundreds of billions of dollars to buy stock in the banks so they'd be recapitalized and start lending again. That didn't work. At this point, all they could really do is just take over the banks outright and force them to lend.

With a sharp reduction in lending, far fewer people can get loans to buy cars. So, car buying is down 25% and all 3 U.S. automakers are about to go bankrupt. With a sharp reduction in lending, businesses can't make capital investments and don't create new jobs.

If the economy is the car, the financial sector is the engine, and credit is the gasoline. The upshot of that right now is that inventories are building, and lots of businesses are cutting production. What's coming next is a massive round of layoffs throughout the manufacturing and retail sectors.

Those crises are in full swing, and coming up next is the credit card crisis. People who have no savings and have been living off their credit cards will start losing their jobs and will default on those credit card debts. Those losses are in the billions of dollars, which is still relatively small, but it will kick off a whole new round of derivative losses. Consumer credit is set to dry up by 45% early next year. The mortgage crisis is going to continue for at least another year, and there is probably another 20% left to squeeze out of home values before they hit their floor.

There simply is no place left to turn to keep consumption going at the artificially high levels of the past six years. All credit is tapped out. Consumption will track down towards real income, and real income will be in sharp decline due to job losses. It adds up to a massive reduction in the size of the U.S. economy.

So the job losses will hit just as the economic downturn gets worse, and by worse, I mean the steepest downturn since World War II. It won't look quite like the Great Depression, since there is a social safety net now, but if you're in your seventies, you've probably already lived through the best economic times of your life.

[Extra Stout]

double post due to logout glitch

[Extra Stout]

Our public debt/GDP ratio stands around 360% today. It's gonna get a lot deeper, soon.That is not correct. It is 65%.

[Extra Stout]

I say March because the layoffs will start to hit hot and heavy after the new year, as will the credit pullback, and you'll start to see the effects in your everyday lives.

[2centsworth]

This gets complicated and long.

The U.S. economy technically has been in recession for a year, and unemployment is usually a lagging indicator. That means that people don't start losing their jobs en masse until the economy has been bad for a while.

Usually, recessions are short, and by the time unemployment peaks, the economy has already started recovering.

Not this time.

The United States has been in a bubble economy for six years. There has been essentially no real economic growth under the Bush Presidency. Due to a stagnation and decline in wages for all but the top few percent of Americans, there is not enough income to stimulate real growth. This was made up temporarily by the development of credit, real estate, and financial bubbles.

The credit bubble was simply easy credit with low interest rates that allowed people to borrow large amounts of money to fuel their consumption (think credit cards). The real estate bubble was a credit bubble applied to real estate, that allowed people to secure mortgages for values far exceeding what they could have secured in previous years. The financial bubble was the deregulation of derivatives that basically allowed investors to "bet" on debts like mortgages, so that the money riding on debts was many, many multiples the value of the debt itself.

The reason banks gave these bad loans out is that they convinced themselves real estate prices would never go down again -- they ignored reality.

As home values increased during the bubble, homeowners were allowed to borrow against those increased values, and they poured that money into consumption. But those increased home values were not sustainable, and once the bubble popped and prices fell, their debt was unsecured. Even if they were to lose their homes, the bank still could never get all its money back.

The derivative bubble is really the death blow to the economy. There were hundreds of billions of dollars of bad mortgages given to people who couldn't afford them, but that alone could not kill the economy. There were tens of billions of dollars of bad home equity after the bubble popped. These could not kill the economy. But the derivatives against these loans are in the quadrillions of dollars, i.e. thousands of trillions. This is several hundred times the size of the entire U.S. economy.

How could this be? Well, as these markets became deregulated, Wall Street came up with ever more complex financial instruments for packaging together securities and derivatives. Take the subprime mortgages, for example, which were the bad loans given to bad credit risks where the bank was counting on a foreclosure so it could get the house back after it had appreciated in price (except the price collapsed instead). These are very risky loans, and if you were to assemble a security based upon them, a buyer would demand a very high interest rate on it, since it is a "junk bond," so the issuer of those mortgages would not get paid much for selling off a bunch of bad mortgages. But what these firms did is set up a complex hierarchy of securities based upon these bad mortgages. The first set would be like "preferred stock," that is, if anything happened, whoever held them would be first in line to get paid. Then the second set would pay off, then the third set, and so forth. The trick is that the first set would get a very high bond rating, like AA/AAA, so those firms could package up bad loans, basically launder them into high-grade bonds, and get a very high price for them.

The problem was that once real estate prices fell, all those bonds, regardless of rating, were utterly worthless.

And since they were high-rated bonds, big banks and pension funds had snapped them up, and were left holding the bag.

But even that would not have been enough to kill the economy.

No, the Wall Street guys had to come up with yet another layer of derivatives, called credit default swaps. Once upon a time, these were like insurance against bad debts. You, the creditor, would pay a third party for a CDS, and if your debtor defaulted, the third party would pay you some sum of money. Then they were deregulated early this decade, so that anybody could get a CDS on any loan, regardless of whether they were a party to it. This sparked a free-for-all of investors making bets back and forth on whether a particular debtor would pay back his debts. Then there would be on CDS's on CDS's. This escalated to the point where there are now quadrillions of dollars of outstanding CDS's, and a relatively small default, like on a subprime mortgage, for example, can result in billions of dollars of losses.

And the banks and institutions are so deeply wrapped up in CDS's, that for any given default, billions of dollars change hands back and forth, and they have no idea who is solvent and who isn't anymore. So, they are deathly afraid to lend to anybody that is even remotely a risk, even fellow banks, much money. Banks that were too heavily tied to bad mortgages and bad credit default swaps quickly went under, and their bankruptcies trigger other defaults that threaten to put other banks under the next day.

In order to have a prayer of surviving, the leftover banks need to increase their cash reserves, and that means they stop lending. But since we've gotten to the point where nobody has any savings anymore, and the whole consumption-based economy was based on shaky credit, it's like Wiley E. Coyote running off the cliff.

Or, it's an eerie reprisal of what happened to the economy in 1929. After the stock market crashed, people didn't end up in soup lines the next day. It was well into 1930 before suffering hit ordinary folks.

So credit is drying up like the Mojave Desert, and we're tumbling headlong towards another Great Depression. The federal government has desperately been trying to stem the tide by throwing hundreds of billions of dollars at banks to buy their bad loans. That didn't work. So they stopped that and instead threw hundreds of billions of dollars to buy stock in the banks so they'd be recapitalized and start lending again. That didn't work. At this point, all they could really do is just take over the banks outright and force them to lend.

With a sharp reduction in lending, far fewer people can get loans to buy cars. So, car buying is down 25% and all 3 U.S. automakers are about to go bankrupt. With a sharp reduction in lending, businesses can't make capital investments and don't create new jobs.

If the economy is the car, the financial sector is the engine, and credit is the gasoline. The upshot of that right now is that inventories are building, and lots of businesses are cutting production. What's coming next is a massive round of layoffs throughout the manufacturing and retail sectors.

Those crises are in full swing, and coming up next is the credit card crisis. People who have no savings and have been living off their credit cards will start losing their jobs and will default on those credit card debts. Those losses are in the billions of dollars, which is still relatively small, but it will kick off a whole new round of derivative losses. Consumer credit is set to dry up by 45% early next year. The mortgage crisis is going to continue for at least another year, and there is probably another 20% left to squeeze out of home values before they hit their floor.

There simply is no place left to turn to keep consumption going at the artificially high levels of the past six years. All credit is tapped out. Consumption will track down towards real income, and real income will be in sharp decline due to job losses. It adds up to a massive reduction in the size of the U.S. economy.

So the job losses will hit just as the economic downturn gets worse, and by worse, I mean the steepest downturn since World War II. It won't look quite like the Great Depression, since there is a social safety net now, but if you're in your seventies, you've probably already lived through the best economic times of your life.


I can only find one flaw in this analysis. The Quadrillion figure in loses. I know the loses are huge, but know one really knows how huge, no? Where are you getting your estimate, because a Quadrillion dollar hole we can not recover from.

[clambake]

i think unemployment will peak around 13%. (which will be a monster)

[Extra Stout]

I can only find one flaw in this analysis. The Quadrillion figure in loses. I know the loses are huge, but know one really knows how huge, no? Where are you getting your estimate, because a Quadrillion dollar hole we can not recover from.

There are in fact several quadrillion dollars in outstanding CDS's. Now investors play both sides, so if a trillion dollars of CDS's settle, maybe only $5 billion changes hands. Or maybe $100 billion does. The banks don't know, and that uncertainty freezes them up into total risk aversion.

[Extra Stout]

Oh, there is a small chance that the financial sector's losses due to the credit default derivatives crisis are in fact larger than the GNP of the United States of America, and that we are all in fact bankrupt.

[Wild Cobra]

i think unemployment will peak around 13%. (which will be a monster)

I haven't tried at all to verify, but I heard they are almost 20% in Oregon.

[clambake]

I haven't tried at all to verify, but I heard they are almost 20% in Oregon.

i'm talking coast to coast average.

[2centsworth]

There are in fact several quadrillion dollars in outstanding CDS's. Now investors play both sides, so if a trillion dollars of CDS's settle, maybe only $5 billion changes hands. Or maybe $100 billion does. The banks don't know, and that uncertainty freezes them up into total risk aversion.

bets are net zero sum.

[Extra Stout]

bets are net zero sum.
But you don't know if the banker next to you won or lost his bets, so you don't know whether he'll be able to repay that overnight loan tomorrow.

[2centsworth]

But you don't know if the banker next to you won or lost his bets, so you don't know whether he'll be able to repay that overnight loan tomorrow.

correct, so it's a transparency problem more than a money problem. (oversimplified on my part I'm sure)

[Extra Stout]

correct, so it's a transparency problem more than a money problem. (oversimplified on my part I'm sure)
That's part of it, and if you're the banker who lost his bets, opacity is your friend.

[2centsworth]

That's part of it, and if you're the banker who lost his bets, opacity is your friend.

that's what human nature will tell them, but I could argue that opacity isn't there friend. btw, I'm guessing most of the losers are insurers and hedge funds and not banks.

[Extra Stout]

that's what human nature will tell them, but I could argue that opacity isn't there friend. btw, I'm guessing most of the losers are insurers and hedge funds and not banks.
WaMu, Wachovia, Citi were among the big losers.

[2centsworth]

WaMu, Wachovia, Citi were among the big losers.

Citi is a quasi-bank and an abomination of the abolition of glass-steagel.

WaMu originated and serviced most of their sub-prime notes is my understanding.

I'm not clear on Wachovia.

[BradLohaus]

That is not correct. It is 65%.

He must be including all of the unfunded entitlements along with the public debt. If you do that then %360 sounds close; that number is about $60 trillion now, and currently about $500,000 per household.

Nobody should count on the government to pay you what they really owe you, in real terms. Great thread.

[PixelPusher]

True. People who live in the favelas in Brazil figure out a way to survive and Americans will too.

http://www.jointsoftime.org/additional/images/rarely/favelas.jpg

[Cant_Be_Faded]

ES, explain to a layman like me how a 3.3% rate on a 30 year treasury bond is an indicator, if you don't mind.

[Extra Stout]

ES, explain to a layman like me how a 3.3% rate on a 30 year treasury bond is an indicator, if you don't mind.
Low bond yields mean high bond prices, which mean that investors are so risk-averse that they are willing to accept a very low interest rate.

This is amidst an environment when the federal fund interest rate is just 1%.

A liquidity trap is when interest rates are close to zero but still fail to stimulate the economy because nobody is willing to lend or make investments with any risk. Once that happens, the central bank no longer can use monetary policy to stimulate the economy. It is likened to "pushing on a string."

[Extra Stout]

Looking at the 30-year-bond, it's been going with a six-month coupon of 4.5%, so if the current yield is 3.3%, investors are paying $135 for every $100 in par value. That's a tremendous premium.

[xrayzebra]

This gets complicated and long.

The U.S. economy technically has been in recession for a year, and unemployment is usually a lagging indicator. That means that people don't start losing their jobs en masse until the economy has been bad for a while.

Usually, recessions are short, and by the time unemployment peaks, the economy has already started recovering.

Not this time.

The United States has been in a bubble economy for six years. There has been essentially no real economic growth under the Bush Presidency. Due to a stagnation and decline in wages for all but the top few percent of Americans, there is not enough income to stimulate real growth. This was made up temporarily by the development of credit, real estate, and financial bubbles.

The credit bubble was simply easy credit with low interest rates that allowed people to borrow large amounts of money to fuel their consumption (think credit cards). The real estate bubble was a credit bubble applied to real estate, that allowed people to secure mortgages for values far exceeding what they could have secured in previous years. The financial bubble was the deregulation of derivatives that basically allowed investors to "bet" on debts like mortgages, so that the money riding on debts was many, many multiples the value of the debt itself.

The reason banks gave these bad loans out is that they convinced themselves real estate prices would never go down again -- they ignored reality.

As home values increased during the bubble, homeowners were allowed to borrow against those increased values, and they poured that money into consumption. But those increased home values were not sustainable, and once the bubble popped and prices fell, their debt was unsecured. Even if they were to lose their homes, the bank still could never get all its money back.

The derivative bubble is really the death blow to the economy. There were hundreds of billions of dollars of bad mortgages given to people who couldn't afford them, but that alone could not kill the economy. There were tens of billions of dollars of bad home equity after the bubble popped. These could not kill the economy. But the derivatives against these loans are in the quadrillions of dollars, i.e. thousands of trillions. This is several hundred times the size of the entire U.S. economy.

How could this be? Well, as these markets became deregulated, Wall Street came up with ever more complex financial instruments for packaging together securities and derivatives. Take the subprime mortgages, for example, which were the bad loans given to bad credit risks where the bank was counting on a foreclosure so it could get the house back after it had appreciated in price (except the price collapsed instead). These are very risky loans, and if you were to assemble a security based upon them, a buyer would demand a very high interest rate on it, since it is a "junk bond," so the issuer of those mortgages would not get paid much for selling off a bunch of bad mortgages. But what these firms did is set up a complex hierarchy of securities based upon these bad mortgages. The first set would be like "preferred stock," that is, if anything happened, whoever held them would be first in line to get paid. Then the second set would pay off, then the third set, and so forth. The trick is that the first set would get a very high bond rating, like AA/AAA, so those firms could package up bad loans, basically launder them into high-grade bonds, and get a very high price for them.

The problem was that once real estate prices fell, all those bonds, regardless of rating, were utterly worthless.

And since they were high-rated bonds, big banks and pension funds had snapped them up, and were left holding the bag.

But even that would not have been enough to kill the economy.

No, the Wall Street guys had to come up with yet another layer of derivatives, called credit default swaps. Once upon a time, these were like insurance against bad debts. You, the creditor, would pay a third party for a CDS, and if your debtor defaulted, the third party would pay you some sum of money. Then they were deregulated early this decade, so that anybody could get a CDS on any loan, regardless of whether they were a party to it. This sparked a free-for-all of investors making bets back and forth on whether a particular debtor would pay back his debts. Then there would be on CDS's on CDS's. This escalated to the point where there are now quadrillions of dollars of outstanding CDS's, and a relatively small default, like on a subprime mortgage, for example, can result in billions of dollars of losses.

And the banks and institutions are so deeply wrapped up in CDS's, that for any given default, billions of dollars change hands back and forth, and they have no idea who is solvent and who isn't anymore. So, they are deathly afraid to lend to anybody that is even remotely a risk, even fellow banks, much money. Banks that were too heavily tied to bad mortgages and bad credit default swaps quickly went under, and their bankruptcies trigger other defaults that threaten to put other banks under the next day.

In order to have a prayer of surviving, the leftover banks need to increase their cash reserves, and that means they stop lending. But since we've gotten to the point where nobody has any savings anymore, and the whole consumption-based economy was based on shaky credit, it's like Wiley E. Coyote running off the cliff.

Or, it's an eerie reprisal of what happened to the economy in 1929. After the stock market crashed, people didn't end up in soup lines the next day. It was well into 1930 before suffering hit ordinary folks.

So credit is drying up like the Mojave Desert, and we're tumbling headlong towards another Great Depression. The federal government has desperately been trying to stem the tide by throwing hundreds of billions of dollars at banks to buy their bad loans. That didn't work. So they stopped that and instead threw hundreds of billions of dollars to buy stock in the banks so they'd be recapitalized and start lending again. That didn't work. At this point, all they could really do is just take over the banks outright and force them to lend.

With a sharp reduction in lending, far fewer people can get loans to buy cars. So, car buying is down 25% and all 3 U.S. automakers are about to go bankrupt. With a sharp reduction in lending, businesses can't make capital investments and don't create new jobs.

If the economy is the car, the financial sector is the engine, and credit is the gasoline. The upshot of that right now is that inventories are building, and lots of businesses are cutting production. What's coming next is a massive round of layoffs throughout the manufacturing and retail sectors.

Those crises are in full swing, and coming up next is the credit card crisis. People who have no savings and have been living off their credit cards will start losing their jobs and will default on those credit card debts. Those losses are in the billions of dollars, which is still relatively small, but it will kick off a whole new round of derivative losses. Consumer credit is set to dry up by 45% early next year. The mortgage crisis is going to continue for at least another year, and there is probably another 20% left to squeeze out of home values before they hit their floor.

There simply is no place left to turn to keep consumption going at the artificially high levels of the past six years. All credit is tapped out. Consumption will track down towards real income, and real income will be in sharp decline due to job losses. It adds up to a massive reduction in the size of the U.S. economy.

So the job losses will hit just as the economic downturn gets worse, and by worse, I mean the steepest downturn since World War II. It won't look quite like the Great Depression, since there is a social safety net now, but if you're in your seventies, you've probably already lived through the best economic times of your life.

Thanks ES, appreciate the patience to take the time to explain a complicated subject. George will had an article this morning about the problem. His contention is that Obama is trying FDR II, New Deal and that it didn't work then and wont work now. He (Will) contends that the Market did not regain before depression status until the 50's. Which surprised me. I wished Washington would step back and let the business people straighten things out without their interferrence. One thing that you said rang a bell big time with me, if I was in my 70's, I had seen my best days. Well I am well into my 70's and hopefully you are wrong.:lol


There are in fact several quadrillion dollars in outstanding CDS's. Now investors play both sides, so if a trillion dollars of CDS's settle, maybe only $5 billion changes hands. Or maybe $100 billion does. The banks don't know, and that uncertainty freezes them up into total risk aversion.

Yeah ES, I have heard that the schemes "built" could very well equal the worlds total economy or maybe even exceed it. One of the experts said, like you. No one knows how much is really out there.


Oh, there is a small chance that the financial sector's losses due to the credit default derivatives crisis are in fact larger than the GNP of the United States of America, and that we are all in fact bankrupt.

See my comment above.



WaMu, Wachovia, Citi were among the big losers.

Wachovia bought out World Savings, which specialized in the
sub-prime market, if I am not mistaken.

All of you talking unemployment. I was born at the tail-end of the Depression. And I can still remember the very end of it. Everyone was poor in Texas. But my Dad and most of my family all had jobs. Not big paying jobs, but jobs. And my Uncle Lawrence who was a hardest working guy I ever knew, said there was always work here in Texas for those that wanted it. Like I said it may not have paid a lot but it was available. Now I am talking about a guy who would go to the cedar breaks with a double bit axe and cut fence post when he couldn't find other work or got pissed at his boss.

Anyhow, ES thanks again. I hope you keep this thread going. It is
informative. Better than the damn papers who want to slant everything.

[Cry Havoc]

This gets complicated and long

....

So the job losses will hit just as the economic downturn gets worse, and by worse, I mean the steepest downturn since World War II. It won't look quite like the Great Depression, since there is a social safety net now, but if you're in your seventies, you've probably already lived through the best economic times of your life.

You deserve a Spur under your avatar or something for that. That was absolutely brilliant and very easy to understand. You might have just typed a summary of what happened, but I feel much more informed about the situation now. It might be the best post I've read on this website, and that's saying something. Major props to you for that. I read the whole post. Feel free to share more, because I've yet to see this laid out so well and clearly anywhere else.

[ChumpDumper]

Pfft. All he had to say was "It's Carter's fault."

[Wild Cobra]

Pfft. All he had to say was "It's Carter's fault."
I just hope that president Obama isn't the second coming of president Carter.

[ChumpDumper]

I'm sure Republicans will try to blame Obama for the recession in 2042.

[xrayzebra]

I'm sure Republicans will try to blame Obama for the recession in 2042.

Ah yes, leave it to Chump to screw up a decent thread. He is like that
little kid, me, me, me, I have something to say.....whaaaaaaaaa.
And like that little kid, he actually has nothing to say. And does it well.

[ChumpDumper]

Ah yes, leave it to Chump to screw up a decent thread. He is like that
little kid, me, me, me, I have something to say.....whaaaaaaaaa.
And like that little kid, he actually has nothing to say. And does it well.You mad?

ES actually brought up the Republicans' Carter canard in another thread. It was a little joke echoing that.

I never expected you to be smart enough to understand.

[xrayzebra]

Ahhhh, I am so sorry. I must have missed it. I take it all back.

[Extra Stout]

You mad?

ES actually brought up the Republicans' Carter canard in another thread. It was a little joke echoing that.

I never expected you to be smart enough to understand.
I said that back when I was a Republican; you can't hold it against me.

[ChumpDumper]

All is forgiven.

[2centsworth]

I said that back when I was a Republican; you can't hold it against me.

im with you on the problems of deregulation
. However, you described two bubbles that had little to do with deregulation. Also, you went on to agree that cds are more a transparency issue than a money issue. Yes, the system is clogged, but the national wealth was inflated and deflated because of fannie freddies 2 percent capital reserve requirements.

Am i wrong, and if so, why?

[Extra Stout]

im with you on the problems of deregulation
. However, you described two bubbles that had little to do with deregulation. Also, you went on to agree that cds are more a transparency issue than a money issue. Yes, the system is clogged, but the national wealth was inflated and deflated because of fannie freddies 2 percent capital reserve requirements.

Am i wrong, and if so, why?
The deregulation of derivatives has had an effect that outweighs the credit and housing bubbles by orders of magnitude.

That the CDS issue pertains more to transparency than money does not somehow make it less severe. What those instruments have done is completely obliterate the ability of the financial markets to assess risk, thereby causing them to cease functioning.

The shutdown of the credit markets has been the difference between recessions and depressions in U.S. history since the Civil War.

[ChumpDumper]

Regarding bad debt: it's not the crime, it's the cover up.

[Viva Las Espuelas]

I'm sure Republicans will try to blame Obama for the recession in 2042.true, and bush will be blamed for everything up til then.

[TDMVPDPOY]

why invest into bonds,

when deposit accounts can give you 4.5-5% return?

or if you want go buy property if you can afford it and ride it out on rental income till property prices goes back up and sell.......

[clambake]

why invest into bonds,

when deposit accounts can give you 4.5-5% return?

or if you want go buy property if you can afford it and ride it out on rental income till property prices goes back up and sell.......

do you have any idea how many people are about to be laid off?

[Cant_Be_Faded]

Low bond yields mean high bond prices, which mean that investors are so risk-averse that they are willing to accept a very low interest rate.

This is amidst an environment when the federal fund interest rate is just 1%.

A liquidity trap is when interest rates are close to zero but still fail to stimulate the economy because nobody is willing to lend or make investments with any risk. Once that happens, the central bank no longer can use monetary policy to stimulate the economy. It is likened to "pushing on a string."

Ehhh.. still don't get it. I suck at economics.

[2centsworth]

The deregulation of derivatives has had an effect that outweighs the credit and housing bubbles by orders of magnitude.

That the CDS issue pertains more to transparency than money does not somehow make it less severe. What those instruments have done is completely obliterate the ability of the financial markets to assess risk, thereby causing them to cease functioning.

The shutdown of the credit markets has been the difference between recessions and depressions in U.S. history since the Civil War.

The deregulation of derivatives or calling insurace contracts credit default swaps? Derivatives are very useful tools. Bypassing capital requirements by calling an insurance contract a credit default swap is something entirely different.

Also, the deleveraging may be a blessing in disguise.

[mouse]

Canada is looking better each day.

[spurster]

Also, this interest rate is low despite a huge deficit. I've always thought that interest rates would shoot up at some point with our government's deficit spending, but demand has remained high for many years even through a bullish stock market. I suppose money from overseas kept interest rates down.

[RandomGuy]

Liquidity trap. The Fed is now powerless to do anything to stop the fall into extended depression.

Americans have no savings, massive debt, vanishing credit, monetary policy is already at the end of its rope, and we haven't even started the worst part yet.

The only thing left to try is good ol' Keynesian government fiscal stimulus on a massive scale, and just hope the U.S. can borrow enough money to do it.

You probably look around you and think, "What is ES babbling about? Things don't look so bad around here."

By March you will understand.

I have told everyone I care for to look out, start putting some cash away, and pay down their variable interest debt.

[RandomGuy]

weimar republic?

Nah. Weimar was a weak, fairly incompetant government in a country with no history or tradition of democracy.

The outgrowth of that was that it concentrated a lot of power in the executive branch with a very weak legislative branch.

This was, by comparison, far more than the US Constitution allows, even with the current pushing by the executive for extensions/expansions of executive power.

(note: RG has a degree in German, and reads German textbooks)

I still have the text book I read that in somewhere in storage if someone would like the name. It was high-school level, but still a fair textbook.

[RandomGuy]

That is not correct. It is 65%.

That is just Federal Debt. Don't forget city and state debt as well.

You might like this one:
The Grandfather Economic Report.

http://mwhodges.home.att.net/\

http://mwhodges.home.att.net/state-local-govt-debt.gif

or simple total, overall debt, versus income:

http://mwhodges.home.att.net/nat-debt/natdebt-vs-natincome.gif

Eek.

I have been saying for years that we need to either curb federal spending, or raise taxes enough to start paying down the debt we have been accumulating since the moron Reagan borrowed us into a hole.

Yeah, that's right, I just called Saint Ronnie a moron.

[RandomGuy]

Canada is looking better each day.

Care to guess who Canada's largest trading partner is?

After that, then tell me what effect a massive slowdown in the US economy will have on US purchases of Canada's exports, mainly raw materials.

WHEEEE.

ok, enough of my posts.

I will leave with this thought and the biggest difference between 1932 and today:

International trade as a percentage of global GDP is much, much higher.

The US as a proportion of that global GDP has been shrinking for years. We will still take a good part of the global economy with us, but the ability to trade and move capital to where it is productive has increased.

I think that this means that we will bounce back a bit sooner than some might think. That and the lack of protectionist tariffs will make the overall effect on living standards somewhat more mitigated than in 1932.

[smeagol]

Thanks ES :tu

[temujin]

Great thread.

Except for the quadrillions, because the number is so high that is essentially irrelevant.

[temujin]

Oh and the recovery will be led by technology, as always.

Just open the drawers and start working on the patents.

[RandomGuy]

Oh and the recovery will be led by technology, as always.

Just open the drawers and start working on the patents.

I think so as well.

Technology has a way of sneaking up on us when we least expect it.

[Nbadan]

....the eventual recovery will be led by the internet....

[Nbadan]

Palin's a grandma and known unknowns....

U2qsagnNpNU