Page 4 of 4 Monetarism enters bankruptcy
By Henry C K Liu
ABS holdings which, when applied to a market decline, exponentially drove
prices even lower.
Large US investment banks had pooled subprime residential ABS totaling $383
billion and sold the paper to investors worldwide in 2006. By September 2007,
21%, or about $80 billion worth, of the mortgage securities were in default,
plus another $20 billion sold by smaller firms. There were $18 trillion of all
forms of outstanding ABS, and market analysts estimated at the time that
marked-to-market losses would be in the range of $400 billion to $600 billion.
Yet media reports cited only about $150 billion of acknowledged
losses as of the end of 2007. The trough, of which no one had any reliable
estimate, remained in the unknown future despite the Federal Reserve's frantic
rate reductions, which by December 2008 has reached near zero.
The impact of the subprime defaults had been magnified as firms purchased for a
fee slices of these original-rated pools and repackaged the assets a second
time, rated them a second time, and later sold them as lower-tiered units at
higher yields to investors with a bigger risk appetite. The impact has been
global, as most international money center banks have offices in all major
financial centers around the world. (See the three-part
Pathology of Debt, Asia Times Online, November 27-29, 2007.)
Going forward, the credit crisis will bring down the retail and office
real-estate sectors in all economies as a global re-pricing of risk alters the
viability of maturing medium-term loans coming due in coming years. From early
mid-2004 to mid-2007, real-estate developers, lenders and property owners used
a menu of complex financial instruments to gain access to low-cost funds and
shift risk off their balance sheets to the investing public. Easy access to
credit had driven capitalization rates way down and debt-financed deal volumes
up to new record levels every year since 2002. Institutional-grade assets had
been priced using exponents in future cash-flow assumptions in an
upward-bending positive parabolic curve. It is inescapable that when global
credit markets turn sour, the effect is an equally downward-bending negative
parabolic curve.
To be fair, Bernanke was in good company among establishment experts of equally
unjustified complacency. Brookings Policy Brief Series #164 dated October 2007,
three months after the credit crisis imploded, used as headline - "Credit
Crisis: The Sky is not Falling". The brief by Anthony Downs, who describes
himself on his website as the "World's Leading Authority" on real estate and
urban affairs, asserts that " … the facts hardly indicate a credit crisis. As
of mid-2007, data show that prices of existing homes are not collapsing.
Despite large declines in new home production and existing home sales, home
prices are only slightly falling overall but are still rising in many markets.
Default rates are rising on subprime mortgages, but these mortgages - which
offer loans to borrowers with poor credit at higher interest rates - form a
relatively small part of all mortgage originations. About 87 percent of
residential mortgages are not subprime loans, according to the Mortgage Bankers
Association's delinquency studies. Subprime delinquency rates will most likely
rise more in 2008 as mortgages are reset to higher levels as interest-only
periods end or adjustable rates are driven upward. Unless the US economy dips
dramatically, however, the vast majority of subprime mortgages will be paid.
And, because there is no basic shortage of money, investors still have a
tremendous amount of financial capital they must put to work somewhere."
However, while this complacent view was widely held in the financial
establishment, not everybody was drinking the Cool-Aid. Instead of "tremendous
amount of financial capital", the entire financial sector was seriously
undercapitalized as distressed debts added up losses. Warnings had been
publicly aired months before the credit crisis imploded in July 2007 by a few
lonely voices that the subprime mortgage bubble would burst and its effect
would spread globally, granted that such warnings had been summarily dismissed
by the establishment media. (See
Why the sub-prime mortgage bust will spread, Asia Times Online, March
17, 2007.)
Bernanke exposed
By December 2008, 18 months after the credit crisis broke out in July 2007,
events have conclusively proved that Bernanke's faith in the magic of the
Greenspan put had been misplaced. Decades of misapplication of Friedmanesque
monetarism had driven the doctrine into theoretical bankruptcy. Monetarist
measures not only fail to revive an economy caught in a global debt tsunami;
there is also clear evidence that the liquidity cure devised by Greenspan has
eventually run out of ammunition after the serial bubbles got bigger each time
to paper over the previous one. The Greenspan put does not work for a stalled
economy facing a liquidity trap of absolute preference for cash. It only adds
more water to a raging flood of debt to threaten even the shrinking remaining
high ground.
The flaw in his faith in self-regulating monetarism that Greenspan openly
confessed before Congress apparently did not get through to Bernanke, who
continues to apply the Greenspan put. Bernanke's futile monetary moves to save
wayward financial institutions have managed only to increase the immunity of
the deeply wounded economy against any Keynesian fiscal cure attempted by the
next occupant of the White House and his economic team.
Bernanke made the same mistake of obstinate denial in the early phases of the
economic meltdown from a debt crisis even after his acceptance eight years
earlier of Friedman's counterfactual conclusion that the Fed in 1930 failed to
act in time to respond effectively to the oncoming disaster with bold monetary
countermeasures. Again, the world missed another opportunity to test if
preemptive Keynesian fiscal cures would work.
More fundamentally, president Herbert Clark Hoover (1929–1933) should have
applied Keynesian demand management through fiscal spending to maintain full
employment immediately after the 1929 crash, if not before, rather than a
timely monetary cure as proposed by Friedman in hindsight. No recovery from
speculative excess can be expected without a policy-induced rise in employment
and wage income to catch up with an asset price bubble. It was true in 1929;
and it is true today.
Unfortunately, the rescue approach by the George W Bush administration led by
Treasury Secretary Henry Paulson and the Bernanke Fed has been focused on
saving distressed financial institutions by providing taxpayers' money to
restructuring bad debts and de-leveraging overblown balance sheets. This
approach inevitably pushes already stagnant wage income further down, with more
layoffs and ruthless renegotiation of already draconian labor contracts, to cut
operating cost. All this does is to reinforce the downward market spiral by
transferring financial pain to innocent workers while not helping the economy
with a needed revival of consumer demand.
Trillions of dollars of good taxpayer money are being thrown after bad debts
concocted by unprincipled financiers into a crisis black hole. This money will
have to be repaid in coming years by taxpayers while supply-siders are
clamoring for tax cuts for corporations, on capital gains and for high-income
earners. This means the future tax bill to pay for the Greenspan put will be
borne by low- and middle-income wage earners. Thus far in this financial
crisis, the Bernanke Fed has sown the seeds not for a quick recovery but for a
decade or more of stagflation for the US and the global economy.
NEXT:Central banking practices monetarism at the expense of the
economy
Henry C K Liu is chairman of a New York-based private investment group.
His website is at http://www.henryckliu.com.
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