No Return to Normal

[katty]

more: http://www.washingtonmonthly.com/features/2009/0903.galbraith.html

Why the economic crisis, and its solution,
are bigger than you think.

By James K. Galbraith

EXCERPT

That chance can be assessed, of course, only by doing what any reasonable private investor would do: due diligence, meaning a close inspection of the loan tapes. On the face of it, such inspections will reveal a very high proportion of missing documentation, inflated appraisals, and other evidence of fraud. (In late 2007 the ratings agency Fitch conducted this exercise on a small sample of loan files, and found indications of misrepresentation or fraud present in practically every one.) The reasonable inference would be that many more of the loans will default. Geithner’s plan to guarantee these so-called assets, therefore, is almost sure to overstate their value; it is only a way of delaying the ultimate public recognition of loss, while keeping the perpetrators afloat.

Delay is not innocuous. When a bank’s insolvency is ignored, the incentives for normal prudent banking collapse. Management has nothing to lose. It may take big new risks, in volatile markets like commodities, in the hope of salvation before the regulators close in. Or it may loot the institution—nomenklatura privatization, as the Russians would say—through unjustified bonuses, dividends, and options. It will never fully disclose the extent of insolvency on its own.

The most likely scenario, should the Geithner plan go through, is a combination of looting, fraud, and a renewed speculation in volatile commodity markets such as oil. Ultimately the losses fall on the public anyway, since deposits are largely insured. There is no chance that the banks will simply resume normal long-term lending. To whom would they lend? For what? Against what collateral? And if banks are recapitalized without changing their management, why should we expect them to change the behavior that caused the insolvency in the first place?

The oddest thing about the Geithner program is its failure to act as though the financial crisis is a true crisis—an integrated, long-term economic threat—rather than merely a couple of related but temporary problems, one in banking and the other in jobs. In banking, the dominant metaphor is of plumbing: there is a blockage to be cleared. Take a plunger to the toxic assets, it is said, and credit conditions will return to normal. This, then, will make the recession essentially normal, validating the stimulus package. Solve these two problems, and the crisis will end. That’s the thinking.

But the plumbing metaphor is misleading. Credit is not a flow. It is not something that can be forced downstream by clearing a pipe.

[Warpy]

1. I don't want a return to "normal"

since that meant runaway speculation at the top and crushing debt at the bottom.

I also want to see a lot of re regulation before banks are allowed to dump all their bad bets on we the people, ensuring there will be no return to "normal."

[katty]

2. indeed, that is not normal, unless you prefer criminal activity

that, apparently runs on a loop.

[Hawkowl]

3. Terrifying to most people

I think Galbraith is exactly right and this is why we have such intense true believers in Obama, literally screaming down anyone who is trying to sound the alarm on Giethner's disaster of bailout plan.
Using Clinton's advisors and strategies will not to take us back to the 90's. It was all an illusion generated by massive credit bubbles facilitated by fraud and no oversight. This reality is hard for a lot of people to swallow and makes people very angry.

Giethner has fundamentally misdiagnosed the economic problem and thus, his solution, is completely inappropriate, and probably will make the situation worse. The parallels between the Great Depression and now are beyond alarming. People thought, and still think, that the crash of 1929 was the big one, but in actuality, after two and a half years of half assed banking solutions and denial, 1932 was THE big crash that really solidified the Great Depression. It appears that we are going to have to repeat history. Hopefully, we will not have to repeat a world war.