The financial markets are in quite fragile condition and I think absent a plan they will get worse,” Bernanke said.
Ominously, he added, “I believe if the credit markets are not functioning, that jobs will be lost, that our credit rate will rise, more houses will be foreclosed upon, GDP will contract, that the economy will just not be able to recover in a normal, healthy way.”
GDP is a measure of growth, and a decline correlates with a recession.
Dodd later spoke disparagingly of the administration’s proposal. “What they have sent us is not acceptable,” he told reporters after presiding over a lengthy Senate Banking Committee hearing at which Bernanke and Treasury Secretary Henry Paulson urged swift action by Congress.
I’ll take the recession, thank you.
Me too. What ever happened to the ability to “fail”. Isn’t that just as American as success? There is no value to winning and success if every time a financial institution fails, we bail them out. That’s NOT the American value system I was taught.
Bernanke, Paulson, and other elite policymakers have been telling us we need the bailout to avoid a global financial meltdown. Now Bernanke stresses that without the bailout we will have a worse recession than we otherwise would.
If that’s the choice, I too would opt for the recession (which we’re going to have anyway). Most Americans would, I suspect, make the same choice.
I’d much rather have recession, (and even depression which may happen) than have the Wiemar Republic/Zimbabwe style hyperinflation that Paulson’s plan will provide.
In a Depression, there is no money but food is cheap and the poison of excess debt is wrung out of the system. In hyperinflation there is no money and food is either exorbitant or unobtainable and the debt load worsens until the only people who are not in penury are the bankers.
What’s really going on here is that political types (of both parties) and bankers are all absolutely terrified of D-E-F-L-A-T-I-O-N.
Inflation and deflation are everywhere and always monetary phenomena — that is, a function of the money supply. Simply described, inflation is an increase in available money in relation to available good and services. Cash chasing goods, if you will. Prices will rise.
Deflation, OTOH, is a decrease of available money in relation to goods and services. Goods chasing cash. Prices will fall. Inflation rewards borrowers and punishes savers. Deflation does the opposite.
Here’s the bind. [b]Fannie Mae and Freddie Mac were the Fed’s overwhelmingly favourite pathway for increasing the “money” supply.[/b] It’s much too involved to describe here, but briefly new [i]debt[/i] increases the “money” supply by about twice as much as the amount borrowed.
Dealing with debt, however — whether by repayment or default — decreases the “money” supply by the same amount. Decreasing the money supply is profoundly de-flationary, and will encourage (or force) ever-increasing numbers of people to deal with their debt one way or the other. Lather. Rinse. Repeat.
This is what the authorities wish to avoid at nearly all costs. They would vastly prefer to inflate the debt away at a moderate rate … because … it maintains the illusion of responsibility and prudence.
What we’re facing here is a classic [b]liquidity trap[/b] in which people will not (or cannot) borrow, even as interest rates dive towards zero. Japan has not yet emerged from its nearly 20-year liquidity trap. Once borrowing crashes, central banks have no means by which to increase the money supply.
The take-home message is that deflation is on its way and the proposed bail-out can only slow its advance. There are no longer any collective solutions. If you are in debt, do you best to get out. Liquidate what you can and pay down your debt.
The essence of the matter is this: Once a bubble breaks, it cannot be re-flated. Authorities always try — as with the bail-out — but it never succeeds. Prepare for deflation, and prepare for deflation’s impact on the “least and the last.”
The good news? Deflation always results in improved real wages for ordinary working people. Deflation can make paupers of big debtors, but it can really improve the purchasing power of responsible, ordinary people. Bring it on.
Bart [#5]: How did Fannie and Freddie increase the money supply? And on what basis do you call them “the Fed’s overwhelmingly favourite pathway for increasing the ‘money’ supply”?
#6 Anytime a bank loans money it increases the money supply. The Federal Reserve system is just the exceptional type of bank which can loan money without taking deposits to originate the cash, as it has a printing press to make up for any lack of deposits.
The favorite pathway bit might be overblown, but mathematically it is correct: with F&F;backing most of the domestic mortgage originations by providing local banks the needed cash in lieu of deposits, they artificially pumped up the economy, and in specific the real estate and house construction markets.
I’ll take the recession too. Let capital flow back to productive ends and let the wage-earning class take shelter in falling prices. Bad investment banks should go broke so good investment banks can acquire assets at realistic valuations. And maybe, just maybe, we can start asking why the Treasury and the Fed enable the macro conditions that germinate this “too big to fail” phenomenon.
#6 — late in the thread, I know. Here’s how it worked. The Fed can create a checking account balance out of thin air. This they did.
They wrote checks on this account to Fannie and Freddie, who thus had a larger amount of “cash” available than before. They used this new money to purchase mortgages from outfits such as Countrywide.
Now, Fannie and Freddie has a pack of mortgage securities and Countrywide (in this example … there were plenty of others) has a big infusion of cash. Remember, this “cash” was originally created out of nothing by the Fed.
Countrywide uses its cash to buy bundles of mortgages from the likes of East Gopher Gulch State Bank in South Overcoat, Nebraska. The East Gopher Gulch State Bank uses the cash it receives for selling mortgages onto the secondary market to pay Clarence and Edith when they sell the farm and move into town.
Clarence and Edith deposit that cash in a money market account.
That money market account takes the cash from Clarence and Edith and uses it to buy part of that package of mortgages from Fannie and Freddie, which it will hold as an “asset” backing its deposits, and which it expects will pay more interest that what they’re offering on their money market account.
Clarence and Edith can write checks on their money market account and at that point the Fed’s monetary injection is fully out there as part of the “money supply.”
That’s how it worked, past tense, and both Fannie and Freddie were the preferred pathway as a simple function of the incredible volume of mortgages they handled. The theory was that the “money” supply could be increased this way because Fannie and Freddie were so big it wouldn’t distort the overall system.
In the event, it hasn’t quite worked out that way, has it?
“Anytime a bank loans money it increases the money supply”
Tom [#7]: That doesn’t sound right. Let’s say you borrow $10,000 from a bank to buy my Qing Dynasty spittoon. You receive the $10,000 in cash. You hand me the cash, and I hand you the spittoon. I have $10,000 more cash than before; your bank has $10,000 less; and the money supply remains the same.
As I understand it, bank loans increase the money supply only insofar as the proceeds remain within the banking system, thus increasing bank reserves and facilitating additional lending.
Bart [#9]: Why would the Fed write checks to Fannie and Freddie? What did the Fed get in return?
Bart: Still looking forward to your answer.
Remember that the Fed, when conducting open-market operations to increase the money supply, buys a marketable asset on a well-developed market. The Fed buys U.S. Treasury securities from its network of primary dealers. It pays for the securities by crediting the Federal Reserve Bank account of the seller’s bank. This accounting entry creates money, which then ripples through the banking system. But note that this money-creation occurred because the Fed bought assets (Treasury securities) at market value?
Do you contend that the Fed engages in similar transactions directly with Fannie and Freddie? What, if anything, is the Fed buying? Why does it write checks to Fannie and Freddie?
PS to #12: The middle paragraph should end this way:
“But this money-creation occurs because the Fed buys assets and pays cash for them.”