Think of it as a picture guide to the ongoing earthquake in the world of high finance. Through charts, graphs, and tables, we will try to understand the dimensions of the current financial crisis--its origins and causes, its likely consequences, its potential remedies.
In seeking to understand the crisis, we need to begin with the credit mechanism. We are living through the bust of one of the greatest credit cycles of all financial history. In order get a handle on the seriousness of the bust, we must register the mania that fed the boom.
I look first at some measures indicative of the financial turmoil. For those unfamiliar with the financial markets, this provides a birds-eye view of the most important indicators, together with links for fresh updates.
The next three sections deal with the causes of the crisis, in which we examine the role of the housing boom and bust, the general growth of credit market debt, and the explosion in derivatives. The general pitch here is that the crisis has arisen above all from the extremities of debt and leverage that built up in the financial system over a long period.
Then it’s on to a consideration of consequences and remedies. The basic question--how much insolvency exists within the financial system?--is vital in assessing the wisdom of various bailouts and rescues, the opportunity costs associated with the government-mandated maintenance of the "FIRE" sector (Financials, Insurance, Real Estate), and how the global imbalances that have marked the last fifteen years are likely to change.
I conclude with some lessons and a collection of paper topics for interested students to consider.
The presentation is generally pitched to the intelligent undergraduate who doesn't know much but is eager to learn. Though prepared for anyone who believes, with me, that a chart is worth a thousand words, I put it together with my students primarily in mind. It began as a 25 minute presentation at Colorado College, then grew.
The whole financial crisis now ongoing must appear as fundamentally bewildering to young people, they who just assumed that their parents' generation knew what it was doing. Alas, no. Understanding what is going on is itself very difficult; finding the right answers is a huge challenge. These are notes and fragments to further that undertaking.
There are two ways of navigating this site: through the "Labels" section, which presents each chapter in an orderly fashion, or through the Table of Contents below.
10/30/08
10/18/08
Table of Contents
INTRODUCTION
--The Overall Idea
--Table of Contents
--Summary of Argument
--Updates and Acknowledgments
FINANCIAL STRESS
--Doom Is Busting Out All Over
--World Stock Market Capitalization Crumbles
--Twin Peaks
--Stock Market Volatility
--High Yield Bonds Over 20%
--High Yield Credit Spreads Top Levels of 2003
--AAA Corporate Bonds: Compared to What?
--LIBOR and Financial Stress
--Flame-Broiled Mortgage Spreads
--TED Spread from 1980s
--Commodities Tank
--Consumer Credit Crashing
--One Big Happy Human Family
--The Banking System: The Issue of Trust
--Carry Trades Unwinding
--Measuring Inflation
--Unemployment Mythologies and the "Misery Index"
--If You Want More,
--Minsky Moments
HOUSING BUBBLE
--California at Height of Bubble
--In the Long Run We're All Dead
--Financial Firm Profitability and Real Estate
--The Big House
--Regional Variation in Housing Declines
--US Homeowners with No or Negative Equity
--One in Six Homeowners Under Water
--Future Housing Prices
--Out of Whack: House Prices and Disposable Income
--Rent Ratios Mean Housing Will Fall Further
--A Cautionary Lesson from Japan
DEBT BINGE
--Total Credit Market Debt is Way High
--Debt to GDP from 1920s
--History is Not Bunk
--Profits of Financial Firms
--Debt Fueled the Equity Boom
--Margin Debt
--Consumer Debt Outstanding
--About That Loan
--National Debt as Percent of GDP (from 1950)
--The Two National Debts
--Understated Obligations
--Stairway to Heaven: Yet More Unfunded Obligations
--Total US Debt and US Debt/World Equity Ratio
--2009 Deficit to $2 Trillion, 12.5% of GDP
--Maxims on Debt and Credit
DERIVATIVES JUNGLE
--One More Bad Thing
--Credit Default Swamps
--Happiness Through Bilateral Netting
--The Mothership of the Derivatives Structure: JP Morgan Chase
--Leverage Ratios at European Banks
--Leverage Unbound at the Investment Banks
--Slicing and Dicing Those Damn Derivatives
SCALE OF LOSSES
--Estimates of Losses
--The Housing ATM and Losses on Real Estate
--Losses and Liquidity
--Preparing for a Rainy Day?
--House Debt as Percent of Compensation
--The Importance of Being Credit-Worthy
--A Comparison with Japan
RESCUES AND REMEDIES
--Deteriorating Balance Sheet at the Fed
--The Greatest Bailout of Them All
--Cash for Trash: The Fed's Balance Sheet
--Paulson Plan, circa October 14, 2008
--Zingales is a Hero; Paulson is a Lout
--The Major Scandal
--Last Resort
--Poor Goldman Sachs
--The Grand Alternative
--The US Hedge Fund and the Bond Conundrum
--Uncle Sam's Adjustable Rate Mortgage
--Twin Towers
GLOBAL IMBALANCES
--Crazy World Order
--Deficit on Current Account Contracting
--Our Best Friends: Foreign Central Banks
--Flight to Quality by Foreign Central Banks
--The End of Bretton Woods II
--The Linked Dangers Foretold (Sort Of)
LESSONS
--Six Lessons from the Financial Crisis
--Implications for "Defense"
--Joseph Stiglitz Excoriates Economists
--Paper Topics
--The Ten Commandments
--The Ten Steps
--Further Reading
--Man, Did I Screw Up
--We Value What We Save in a Crisis
--The Overall Idea
--Table of Contents
--Summary of Argument
--Updates and Acknowledgments
FINANCIAL STRESS
--Doom Is Busting Out All Over
--World Stock Market Capitalization Crumbles
--Twin Peaks
--Stock Market Volatility
--High Yield Bonds Over 20%
--High Yield Credit Spreads Top Levels of 2003
--AAA Corporate Bonds: Compared to What?
--LIBOR and Financial Stress
--Flame-Broiled Mortgage Spreads
--TED Spread from 1980s
--Commodities Tank
--Consumer Credit Crashing
--One Big Happy Human Family
--The Banking System: The Issue of Trust
--Carry Trades Unwinding
--Measuring Inflation
--Unemployment Mythologies and the "Misery Index"
--If You Want More,
--Minsky Moments
HOUSING BUBBLE
--California at Height of Bubble
--In the Long Run We're All Dead
--Financial Firm Profitability and Real Estate
--The Big House
--Regional Variation in Housing Declines
--US Homeowners with No or Negative Equity
--One in Six Homeowners Under Water
--Future Housing Prices
--Out of Whack: House Prices and Disposable Income
--Rent Ratios Mean Housing Will Fall Further
--A Cautionary Lesson from Japan
DEBT BINGE
--Total Credit Market Debt is Way High
--Debt to GDP from 1920s
--History is Not Bunk
--Profits of Financial Firms
--Debt Fueled the Equity Boom
--Margin Debt
--Consumer Debt Outstanding
--About That Loan
--National Debt as Percent of GDP (from 1950)
--The Two National Debts
--Understated Obligations
--Stairway to Heaven: Yet More Unfunded Obligations
--Total US Debt and US Debt/World Equity Ratio
--2009 Deficit to $2 Trillion, 12.5% of GDP
--Maxims on Debt and Credit
DERIVATIVES JUNGLE
--One More Bad Thing
--Credit Default Swamps
--Happiness Through Bilateral Netting
--The Mothership of the Derivatives Structure: JP Morgan Chase
--Leverage Ratios at European Banks
--Leverage Unbound at the Investment Banks
--Slicing and Dicing Those Damn Derivatives
SCALE OF LOSSES
--Estimates of Losses
--The Housing ATM and Losses on Real Estate
--Losses and Liquidity
--Preparing for a Rainy Day?
--House Debt as Percent of Compensation
--The Importance of Being Credit-Worthy
--A Comparison with Japan
RESCUES AND REMEDIES
--Deteriorating Balance Sheet at the Fed
--The Greatest Bailout of Them All
--Cash for Trash: The Fed's Balance Sheet
--Paulson Plan, circa October 14, 2008
--Zingales is a Hero; Paulson is a Lout
--The Major Scandal
--Last Resort
--Poor Goldman Sachs
--The Grand Alternative
--The US Hedge Fund and the Bond Conundrum
--Uncle Sam's Adjustable Rate Mortgage
--Twin Towers
GLOBAL IMBALANCES
--Crazy World Order
--Deficit on Current Account Contracting
--Our Best Friends: Foreign Central Banks
--Flight to Quality by Foreign Central Banks
--The End of Bretton Woods II
--The Linked Dangers Foretold (Sort Of)
LESSONS
--Six Lessons from the Financial Crisis
--Implications for "Defense"
--Joseph Stiglitz Excoriates Economists
--Paper Topics
--The Ten Commandments
--The Ten Steps
--Further Reading
--Man, Did I Screw Up
--We Value What We Save in a Crisis
Summary of Argument
The world financial system is undergoing a kind of seizure, with assets crashing more wildly than they have done since the Great Depression. At the core of the crisis is the mayhem in the credit markets, where interest rates are going up sharply. The popping of the housing bubble has brought to dramatic pitch the unsustainable levels of US debt across wide sectors (not just housing). The extreme leverage on dodgy assets characteristic of US and European financial institutions has made many of them insolvent if their assets are judged on a “mark-to-market” basis. Various signs point to a deep recession, at a minimum, possibly much worse.
The financial crisis will have extraordinary implications for just about everything. It marks the birth of a new era quite as much as 9/11 did. We need to reflect about the lessons, nearly all of which are rather grim, and start asking in earnest about the political and economic consequences.
I give US authorities very low marks in their response to the financial crisis. Paulson and Bernanke have mistakenly characterized the crisis as a liquidity rather than solvency issue. They have also failed to introduce any coherent limit on the government’s acquisition of toxic private debt. The Paulson Plan is especially wrong-headed, as being neither equitable to the taxpayer nor efficacious in its stated aim (getting banks to lend again). The commitment of public funds to insolvent institutions must have shareholder wipeouts and debt-to equity conversions as a basic feature. The real bill of the US government’s strategy has been minimized in a kind of shell game, but the opportunity costs will likely prove tremendous. There is much cause for depression in both the terrifying implications of an economic collapse and in the response of US authorities to the crisis.
10/26/08
The financial crisis will have extraordinary implications for just about everything. It marks the birth of a new era quite as much as 9/11 did. We need to reflect about the lessons, nearly all of which are rather grim, and start asking in earnest about the political and economic consequences.
I give US authorities very low marks in their response to the financial crisis. Paulson and Bernanke have mistakenly characterized the crisis as a liquidity rather than solvency issue. They have also failed to introduce any coherent limit on the government’s acquisition of toxic private debt. The Paulson Plan is especially wrong-headed, as being neither equitable to the taxpayer nor efficacious in its stated aim (getting banks to lend again). The commitment of public funds to insolvent institutions must have shareholder wipeouts and debt-to equity conversions as a basic feature. The real bill of the US government’s strategy has been minimized in a kind of shell game, but the opportunity costs will likely prove tremendous. There is much cause for depression in both the terrifying implications of an economic collapse and in the response of US authorities to the crisis.
10/26/08
Updates and Acknowledgments
While I have heard the term “blogbook,” I don’t recall having seen one, despite having spent a good part of my existence in the last six years “surfing the web.” By a blogbook I mean something that, utilizing blogging technology, is to be approached as a book, with a chapter organization and such.
Google's webhosting service, Blogspot, is not made for blogbooks, though it is easily adaptable to that purpose. But one note of caution: Ordering within each of the chapters depends on time of posting, so my time stamps are not necessarily indicative of the actual time the material was posted. I have altered them to allow for an orderly presentation. The initial foray of posts was made in mid-October 2008, and the time-stamps will stay ordered in that time frame; since then, I have mostly been updating with links for further reading. When I make a substantive change to a post, I will signify that by a date at the bottom of the entry indicating the date of the latest update.
Doing a blogbook is an odd writing experience. My normal method is to write something, then fiddle with it endlessly. I always think I’m done, but this invariably proves an illusion. I’m never quite done. I have also found that I have to post something several times before I correct all the typos and haywire formatting. That’s fine if you’re writing a book and no one is reading it, but odd if you’re doing your composition and revision in plain view.
A great many websites that contain charts like those appearing here are in the business of investment advice. They are basically trying to figure out which way the various asset classes are going to move—up or down?—and they attract readers because they help answer the question: where should I put my money?
I do not find that an obnoxious question; I have devoted considerable time, not necessarily well spent, to thinking about that very thing. But the focus of Cause for Depression is otherwise. The question that it asks is not: how is the investor or future pensioner to survive in the coming turmoil? Instead, the focus is on public affairs. What is the nature of the crisis that government must address? Has it responded judiciously to the crisis? What lessons for financial governance may we draw from the experience? What are the implications for the world economic and financial system? I don’t pretend to exhaust these subjects, but they and questions like them are what draw my primary interest in this presentation.
My deeper interest, though one that is barely registered here, is with the implications for American foreign policy. What will be the features of the new era that has now suddenly fallen upon us? How should the nation adapt? The nexus between the financial crisis, on the one hand, and our energy and environmental problems, on the other, also excites my rapt attention. I hope to get to those one of these days.
While I would sincerely like to go to a place where the words “finance” or “derivatives” were never uttered, I will probably keep updating, mostly with links to new information and developments. The financial crisis is a hell of a lot more exciting than baseball, if you ask me, but it does have the aspect of watching a not-so-slow-motion train wreck. Repellent, but enthralling! And very consequential.
When possible, I’ve tried to indicate where to find updated sources of information for the material presented here. Given my harsh view of "derivatives," I'm obliged to say that this compendium is almost entirely derivative. I’m deeply indebted to my blogroll for ideas, inspiration, and many of the charts contained herein.
If you are intrigued by what you find here, my idea for further research is pretty straightforward: Just put my blogroll into your Google Reader, and follow along with Yves, Tim, Mish, Jesse, Mike, Barry, Willem, and the rest as they illuminate the great transformation now occurring.
10/25/08
Google's webhosting service, Blogspot, is not made for blogbooks, though it is easily adaptable to that purpose. But one note of caution: Ordering within each of the chapters depends on time of posting, so my time stamps are not necessarily indicative of the actual time the material was posted. I have altered them to allow for an orderly presentation. The initial foray of posts was made in mid-October 2008, and the time-stamps will stay ordered in that time frame; since then, I have mostly been updating with links for further reading. When I make a substantive change to a post, I will signify that by a date at the bottom of the entry indicating the date of the latest update.
Doing a blogbook is an odd writing experience. My normal method is to write something, then fiddle with it endlessly. I always think I’m done, but this invariably proves an illusion. I’m never quite done. I have also found that I have to post something several times before I correct all the typos and haywire formatting. That’s fine if you’re writing a book and no one is reading it, but odd if you’re doing your composition and revision in plain view.
A great many websites that contain charts like those appearing here are in the business of investment advice. They are basically trying to figure out which way the various asset classes are going to move—up or down?—and they attract readers because they help answer the question: where should I put my money?
I do not find that an obnoxious question; I have devoted considerable time, not necessarily well spent, to thinking about that very thing. But the focus of Cause for Depression is otherwise. The question that it asks is not: how is the investor or future pensioner to survive in the coming turmoil? Instead, the focus is on public affairs. What is the nature of the crisis that government must address? Has it responded judiciously to the crisis? What lessons for financial governance may we draw from the experience? What are the implications for the world economic and financial system? I don’t pretend to exhaust these subjects, but they and questions like them are what draw my primary interest in this presentation.
My deeper interest, though one that is barely registered here, is with the implications for American foreign policy. What will be the features of the new era that has now suddenly fallen upon us? How should the nation adapt? The nexus between the financial crisis, on the one hand, and our energy and environmental problems, on the other, also excites my rapt attention. I hope to get to those one of these days.
While I would sincerely like to go to a place where the words “finance” or “derivatives” were never uttered, I will probably keep updating, mostly with links to new information and developments. The financial crisis is a hell of a lot more exciting than baseball, if you ask me, but it does have the aspect of watching a not-so-slow-motion train wreck. Repellent, but enthralling! And very consequential.
When possible, I’ve tried to indicate where to find updated sources of information for the material presented here. Given my harsh view of "derivatives," I'm obliged to say that this compendium is almost entirely derivative. I’m deeply indebted to my blogroll for ideas, inspiration, and many of the charts contained herein.
If you are intrigued by what you find here, my idea for further research is pretty straightforward: Just put my blogroll into your Google Reader, and follow along with Yves, Tim, Mish, Jesse, Mike, Barry, Willem, and the rest as they illuminate the great transformation now occurring.
10/25/08
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