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Posted by on Feb 20, 2009 in At TMV | 12 comments

S&P: We’re Still Only In The Beginning Stages Of The Credit Crunch

I’ll admit that I’ve said some alarmist stuff about where I think the economic crisis is going, but I’d argue that the alarm is realistic based on the dynamics of the crisis. Some people object and ask why things aren’t that bad yet (only about as bad as the 74 and 81 recessions) if it’s such a big problem. Well, if you’ve ever in a canyon in an arid place like Colorado or Arizona, and there is a heavy rainstorm then you don’t wait around until you actually see the wall of water roaring down destroying everything in its path. The people that have lived around those parts can tell when to be worried or not based on the environment (how much rain there’s recently been) and the dynamics (how much rain has fallen and how long it took). Back when I lived in Colorado, there was a particularly wet spring and one of the heaviest (and longest) rains I’ve seen there and the locals weren’t worried at all; but a few years later during a very dry summer there was a rainstorm that didn’t even dump much (but did it very quickly) and it caused a massive flash flood a couple hours after the rain stopped that killed a few people that didn’t know better.

The point is that the environment and rate of stress is crucial to outcome to predict dynamics, but most people only pay attention to the size of stresses that have occurred already and simply extrapolate. [Note: none of the mainstream economic schools pay attention to what I just said. At all. That’s why they all missed what was going on.] This is why people are so “surprised” when sudden shifts happen. Right now, the financial system has seen quite a bit of loss, but the first stage is mostly over as subprime has been written off completely and there isn’t too much on the immediate horizon. It’s like there was a heavy rainstorm but the skies are getting slightly less gray. However, the “external” stress has set in motion dynamics that won’t be easily overcome, and indeed we haven’t even seen the main wave of the credit crunch if S&P is to be believed. It’s important to note that the problems they are talking about are different than the first two waves of the crisis. The first crunch in fall 07 was from fear of bad debt, the second in fall 08 was from write downs of previous bad debt (which they’re not through yet) but the future crunch is anticipated to be about the lack of present and future good risks due to immense unemployment, bankruptcies, etc.

The moral of the story is that even if banks had good balance sheets, they still wouldn’t want to lend and credit will contract immensely; that is the main flood that hasn’t fully hit yet and that’s what people should focus on.

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Copyright 2009 The Moderate Voice
  • elrod

    So, in other words, we need an even larger government stimulus to create the demand and lower unemployment enough to encourage future lending.

    BTW, we are nowhere near done removing the toxic assets off the balance sheets of major banks. We have two major zombies – Citi and Bank of America – that will have to come up with a plan to sell off its toxic junk immediately or face receivership.

  • Manchester2

    I’m no banking expert. However, there are a lot of banks (and credit unions, for that matter) that indeed are lending. These include thousands of community institutions across the country, like the one for which I’ve been working for the past year-and-a-half. Not every potential lender is a Bank of America or a Citi Bank. One of these small banks must down the road from my house has a large banner out front: “Yes, we’re making loans!” That message has not punched through the static of the incessant negative banking coverage.

    • mikkel

      Manchester: Actually that’s what the point of the link was. She was saying that banks are lending but you have to look at the rate of lending. The way that the economy works, it’s all built on growth not on absolute numbers. So the S&P analyst was pointing out that the “credit crunch” was still seeing positive lending growth but that it was slower than normal and that was causing problems. Now as loans start to mature, if they don’t loan out at the same rate there will be overall contraction and that will be the main part of the crisis.

  • greenschemes

    History is such a great teacher. Those of us who have been waving flags since the Clinton Administration only have to look at what transpired during the roaring 20s.

    During World War I, federal spending grows three times larger than tax collections. When the government cuts back spending to balance the budget in 1920, a severe recession results. However, the war economy invested heavily in the manufacturing sector, and the next decade will see an explosion of productivity… although only for certain sectors of the economy.

    An average of 600 banks fail each year.

    Agricultural, energy and coal mining sectors are continually depressed. Textiles, shoes, shipbuilding and railroads continually decline.

    The value of farmland falls 30 to 40 percent between 1920 and 1929.

    Organized labor declines throughout the decade. The United Mine Workers Union will see its membership fall from 500,000 in 1920 to 75,000 in 1928. The American Federation of Labor would fall from 5.1 million in 1920 to 3.4 million in 1929.

    “Technological unemployment” enters the nation’s vocabulary; as many as 200,000 workers a year are replaced by automatic or semi-automatic machinery.

    Over the decade, about 1,200 mergers will swallow up more than 6,000 previously independent companies; by 1929, only 200 corporations will control over half of all American industry.

    By the end of the decade, the bottom 80 percent of all income-earners will be removed from the tax rolls completely. Taxes on the rich will fall throughout the decade.

    By 1929, the richest 1 percent will own 40 percent of the nation’s wealth. The bottom 93 percent will have experienced a 4 percent drop in real disposable per-capita income between 1923 and 1929.

    The middle class comprises only 15 to 20 percent of all Americans.

    Individual worker productivity rises an astonishing 43 percent from 1919 to 1929. But the rewards are being funneled to the top: the number of people reporting half-million dollar incomes grows from 156 to 1,489 between 1920 and 1929, a phenomenal rise compared to other decades. But that is still less than 1 percent of all income-earners.

    CAN ANYONE SAY DOT>COM????

  • greenschemes

    IN addition Under Roosevelt.

    Congress authorizes creation of the Agricultural Adjustment Administration, the Civilian Conservation Corps, the Farm Credit Administration, the Federal Deposit Insurance Corporation, the Federal Emergency Relief Administration, the National Recovery Administration, the Public Works Administration and the Tennessee Valley Authority.

    In 1935 The Supreme Court declares the National Recovery Administration to be unconstitutional.
    In 1936 The Supreme Court declares part of the Agricultural Adjustment Act to be unconstitutional.
    In 1937 The Supreme Court declares the National Labor Relations Board to be unconstitutional.

    Interesting. No? I wonder why no one was calling for FDR’s head. Or wait. Maybe they were in the day. Funny how time changes perspectives.

    Alarmed by Roosevelt’s plan to redistribute wealth from the rich to the poor, a group of millionaire businessmen, led by the Du Pont and J.P. Morgan empires, plans to overthrow Roosevelt with a military coup and install a fascist government. The businessmen try to recruit General Smedley Butler, promising him an army of 500,000, unlimited financial backing and generous media spin control. The plot is foiled when Butler reports it to Congress.

  • GeorgeSorwell

    Some were calling for FDR’s head.

    Some were calling for the heads of the Supreme Court Justices.

    Life’s a cabaret.

  • greenschemes

    The DOT.COM’s planted the seeds for the failures that were to explode into reality in the turn of the century. Many, many people looked on with great annoyance at the fact that the DOT.COM bubble made so many wealthy, burst and the fall out was minimal.

    So those who set on the sidelines jumped head long into the real estate fiasco and we now have what we now have.

    Greed. Avarice. It goes way beyond Wall Street. Because with the numbers of failed homeowners involved it is apparent that it took two to tango and there are so many cases in this current fiasco of those 30k homeowners who bought with little or no credit hoping to sell in a few months and make 50 or 100k and then do it again.

    I have NO, ZIP, ZERO compassion for those loosing their houses over this. I have a ton of compassion for those that will loose their houses because the economy tanks and they loose their jobs and thus loose their houses.

    During the last 5 years MY wife and I would get about 50 credit card applications per week in the mail. We would get about 25 applications to refinance my home. We would get calls on the Telephone from People accross the country wanting us to refinance and bundle our credit card debt into a second mortgage. The pressure was incessant upon us and Im a trained economist that would tell each one of them to politely get a real job.

    The people I have compassion for are those going to lose their house because they lose their jobs. Not those who had to file bankruptcy because they bought a house that went down in value and so they are all upset that the pad they hoped would lead them to riches and glory is now worthless. Real estate is never worthless.

    Nothing is ever free. Yes people get lucky and get rich. Many did in the DOT.COM and many did on this. But way more then got rich went broke. Its the chance you take. Why didnt we bail out those poor dotcommers too?

  • elrod

    Good historical review, greenschemes.

    The shell of American wealth extended into the 2000s as well.

  • greenschemes

    Banks cannot survive if they do not lend period. While there might be contraction that is to be expected in an economy that was lending without reservations.

    Secondly much of the banking system in this country is actually healthy. Lending continues. Look at the credit unions. They are relatively unaffected by all this because they are member owned and are not expected to make a profit.

    Banks must post profits to succeed. They will lend. It will just be at rates that cause an overinflated and FAT economy to trim down or go on a diet. This nation will save instead of spend like drunken sailors. Saving puts money in banks and credit unions who then have more money to lend.

    Stop the fear mongering. Stop it. Even at the worst of times there will be 125 million working Americans and there will still be 300 million CONSUMING AMERICANS with wants and needs. This is a recession. Not a depression. Recessions are painful and this is going to be very painful but that does not mean the country will go belly up and there will be rich people offering to overthrow the government. Unless of course we continue on with this rant about nationalizing everything in sight because times are tough.

    • mikkel

      During the Great Depression 75% of people were still employed, it was hardly the stone age. It’s hard not to be concerned when people still don’t understand how the financial system works. So yeah, the credit unions aren’t in that bad of shape? So what? They are a small fraction of the mega banks. Just Citi is significantly larger than all credit unions combined.

      Secondly like I said up there and will say again, our entire economic foundation is built on growth and that includes acceleration. When growth contracts then by definition it becomes impossible to pay off some fraction of loans commensurate with the amount of growth decline and how fast it declines. The difference between now and prior recessions is that back then the banks weren’t leveraged as much so they could take a larger hit without being insolvent. Right now the entire banking system (especially Europe) is so leveraged that even the normal rate of defaults causes the whole thing to be insolvent.

      This is going to be a depression, it was always going to be a depression and I personally think it’s unavoidable. I have yet to read anyone that addresses the core problems that doesn’t believe it will be a Depression (defined as 10% GDP contraction) although many of them think it doesn’t have to be as bad as the Great Depression unless we have the wrong reaction. I am pessimistic and think that human nature will cause people to react in the “wrong” way. The sooner everyone wakes up and realizes that “Hey, this is completely different and the exact same dynamics that has led to depressions for hundreds of years” the sooner we’ll stop wasting money on stuff that won’t help (I don’t agree with Elrod that the government can step in to fill the whole gap because it would be about 20% of GDP and the world can’t support that much debt….many parts are already closed off and collapsing because everything is flowing to the US) and set up systems that will minimize the suffering and then when the financial system and personal balance sheets are cleaned up (which may involve nationalization) that’s when the government can step in to spend and when banks will be able to make a lot of productive loans.

      If you don’t believe anything I’ve said, Soros and Volcker are now saying that the environment is becoming worse than the Great Depression when you look at structural weakness and the rate of decline. The first is subjective, but the latter is completely true; Japan’s fall off over the past quarter is faster than any industrialized country ever recorded. And like my analogy, acceleration matters.

  • greenschemes

    Assets increased 6.4 percent to $801.7 billion from $753.4 billion; Credit Unions. 2008.

    Of the top 50 banks the top 5 are in trouble including your Citi, JP Morgan, BA, Wachovia, Wells Fargo. The next 45 banks in size have assets in excess of what the top 5 have. Information Gleaned from the FDIC.

    The top 5 banks even if deemed unsolvent have many portions of them that are profitable and coveted by many aspects of our financial sector. Essentially if the top 5 in trouble were to become insolvent they would take with them about 500-900 billion in write offs while retaining a worth of 900 billion and be recapitalized into smaller and stronger banks.

    Yet if you look at the balance sheets of the Credit unions as well as 45 of the top 50 banks in the Nation the assets available exceed not only your CITI but the top 5 in trouble banks by a factor of 2:1

    In addition this does not even include the 1000’s of other banks whose assets I did not even take into consideration.

    Please stop with the “Sky is Falling.” Unless of course you just like to fear monger.

    • mikkel

      Even by your own calculation (and Roubini’s is slightly worse by starting at the upper end of another $900 billion and topping out at another $1.5 trillion) we’re still looking at 50% of the entire monetary base being written off. Also a lot of the middle tier and small regional banks will soon be insolvent too, not due to mortgages but to CRE loans going bad so you can’t just act like they’re all good. And the central credit union had to just be bailed out (although it’s true that the individual ones are in pretty good shape) but it is going to have major impacts on their operations. Once again, writing off 1/3 of the entire monetary base, combined with reduced leverage going forward will make worldwide US $ debt decrease about 25-40% most likely. It’s hard to tell exactly, because the decreased leverage from around 16x now (20x at the peak) will go back to 10-11x and that is a 30% decrease, plus the decreased base of 50% means a decrease of around 50-70%….but they obviously won’t let the base decrease that much and it may even rise, so it’s hard to tell. Also a ton of the credit wasn’t in the official banking system, but what they refer to as the “shadow” banking system of the hedge funds, etc. that have all blown up completely and are going to lower leverage. You can’t just look at the bank’s balance sheets directly because they sold off most of the stuff, so you have to look at the impact on all sorts of funds and how that will affect growth.

      My point is that you can’t just reduce debt 25%+ and not have a fall in GDP of over 10%, which is the official informal definition of a depression. You might think I’m fear mongering, but — and for the last couple of years since I’ve been convinced by looking at all the data and reading the various arguments — I’m just looking at the numbers and what will happen if we return to the upper levels of sustainability based on the last 60 years (12x leverage, 2.7-3.0 home price to household income ratio, credit extending, etc). That’s it.

      I think people that are refusing to admit this are doing a disservice and making things more dangerous because the Great Depression has been built up to be the worst thing ever and what we have to avoid at all costs, so when we fail to turn around things in the next year everyone is going to start panicking. But I’ve talked with my grandparents at length about this and while it was a very hard time (and their parents were farmers so they had the brunt of it) it wasn’t a complete disaster once the government started doing better with relief. With the excess of food, shelter and other resources, even if there is a depression we should be able to get through it without people threatened on a fundamental level. But if everyone just keeps acting like it’s something that can never happen (and accuse people warning of it as fear mongers without even addressing any of the root concerns about how the economy actually works) then there will be panic and things might get that bad again.

      Anyway it’s a moot point because it’s not like anything I say actually matters and people will think what they want to. I’ve latched onto people far more knowledgeable than me and that have had a consistent hypothesis all this time and have seen it coming step for step (including some of the non-intuititive parts like deflation despite the Fed increasing monetary base 300%) but they are still mostly ignored.

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