Financial China Syndrome
We face a Wall Street “meltdown,” if we don’t give Hank Paulson a Trillion Dollar blank check, right? It occurs that the term is borrowed from what can happen if a nuclear power plant loses coolant. (That’s noo-kew-ler to those of you from Wassilla).
The core would melt through the containment facility and keep going through the ground with nothing to stop it — right through the center of the earth all the way to China, hence the “China Syndrome.” Realistically, the core would stop as soon as it hit the water table, with the unfortunate side-effect of blasting radioactive steam into the atmosphere. (If you’re too young to have seen the movie, I highly recommend it.)
The consensus that we are avoiding a catastrophic Great Depression 2.0 is something everyone who matters seems to take on faith, and by spending a Trillion Dollars we are avoiding a $30 Trillion hit on our economy — a bargain.
I’ve kinda figured that the next industries to close down if this bailout didn’t happen would be the big auto makers, followed closely by the perpetually shaky airline industry. With most of the residents of lower Manhattan on the streets, Detroit turning into a ghost town and Washington having almost no choice but to nationalize the airlines since it would no longer be profitable to run them privately, you can see how quickly commerce would shut down across the nation.
The 25% unemployment of the 1930’s might be overshadowed in a matter of months; and in sheer numbers, the army of people on the streets is unfathomable and would certainly be larger than the original Depression.
So I’m buying it, a bit. Of course, there’s nothing that says the Fed couldn’t have propped up the auto and airline sectors even if the financials were allowed to drown, right? Probably cheaper too, no? Maybe, and frankly I don’t have enough data to even hazard a guess — so I’m just talking through my hat on this, but it feels right.
However, if the financials went down, we probably would be unable to bailout other sectors even if we wanted to do this on an ad hoc basis — Secretary Paulson’s preferred approach right up until the last time we heard the words “The fundamentals of this economy are strong” come out of John McCain’s mouth before he reverted to an Orwellian game of redefining the meaning of the word “fundamentals.”
The financial problem tracks the radioactive nature of nature itself inside a nuclear reactor when the coolant system breaks down and stops regulating the reaction. It’s not a bad metaphor to describe Washington’s failure to pour some water on the out of control investment houses leveraging themselves beyond reason on risky and ridiculously complicated mortgage-backed security instruments. And again, although not that many folks have been talking about it, China comes into play here too — and not just in a metaphorical way.
In USNews, James Pethokoukis mentions in passing the China Syndrome looms large over this whole affair as he tries to get a handle of what we’re trying to avoid.
Now this is all a very rough guesstimate and doesn’t include the costs of all sorts of other ramifications. Here is a fun one: the dissolution of China. Its economy is built for hypergrowth. A dramatically rising standard of living is both keeping the Communist Party in power and keeping the country together. Neither might survive a global economic meltdown. What is the economic impact of that? I don’t know. My guesstimator just blew up.
I think I can flesh this out a bit. The two biggest foreign holders of U.S. public debt, in other words the countries or their central banks that make it possible for us to run this country at a perpetual deficit, are Japan and China at $593 and $518 Billion respectively. This represents nearly half of our total foreign held debt, which in turn is about 44% of the total debt. If you’ve been following along, most of this debt is held in the form of Treasury Bonds which can (in theory) simply be redeemed on demand.
The official explanation why we need to act swiftly on Wall Street is to avoid a credit crunch, where people and businesses needing credit or access to their pre-existing revolving accounts are shut out. That’s bad enough, but what happens when the central bank of China can’t issue credit to it’s companies because of a world-wide squeeze. Evidently, according to Secretary Paulson, the financial world is much like the Internetz, a “series of tubez” that has gotten clogged by the Big Shitpile.
The Trillion Bucks we’re literally flushing down those tubez is supposed to clear out the derivative default credit swaps (crack) that the Wall Street financiers have been smoking through those pipes for the last decade. No one has mentioned it, but if China (and/or Japan, but their credit situation shouldn’t be as vulnerable) can’t work in the normal world of free-flowing credit, they will have no choice but to start cashing in all those T-Bills. That alone would be serious enough, but it would undoubtedly cause a run on the Treasury as the world divests itself of dollars, crashing our currency to the point that a loaf of bread might cost you a hundred bucks, or more, within a month.
That pretty much the end of the world as we know it. That’s why you’re seeing such dramatic moves, serious tones and ghostly white complexions on the faces of the folks who know what’s really happening and know they must do something extraordinary soon. (Also keep in mind that massive global unrest caused by unemployment and hyperinflation was a prerequisite for WWII.)
So no, anyone who is saying, “Hell No” to the bailout or who wants to take their chances with a recession/depression, you obviously have zero idea of just how bad things really could get if we just allow the planet’s capital markets to dissolve — no matter how much those bastards deserve to lose everything for bringing us to this point.
That said, the markets realize that Washington has woke up and will do something — which has slowed the meltdown for now. Still a crisis, sure. But that’s different from an emergency requiring unprecedented plenary powers with a credit card balance the size of the GDP of India and no judicial, administrative or congressional oversight. We’ve got time to do this right. Not a lot of time, but if by Wednesday the headlines are screeching that the deal is bogged down, chalk it up to partisanship and the tired GOP scaremongering we’ve seen again and again as the administration bullies Congress into yet another bad decision.
Frankly, exorbitant CEO pay is a drop in the bucket in all this, even as it becomes a lightning rod issue. Much more important is allowing bankruptcy judges the power to restructure real estate mortgages much like they do with other credit instruments. That move alone will do the most to stabilize the market, keeping more people in their houses and businesses, preventing the scourge of vacancies that are turning residential neighborhoods into ghettos and closing down small businesses (the backbone of our economy) as the surrounding properties lose value in a never ending spiral.
That leaves me with two things to look forward to, John McCain coming out against doing a bailout at all, just to shore up that Maverick myth of his — again proving his sheer ignorance of all things economic; or trying to score cheap debate points Friday if there’s no bill on the PrezNitWit’s desk because Congress decides it’s foolish to set Paulson up as King Henry XXVII and wants to address the real economy — the slump in housing prices that will continue to destroy confidence and add to our troubles if left to fester.
Go ahead John, make my day. Idiot. Please go into your hot-headed desperation mode for all to see.
Several thoughts:
1. Wouldn’t it be ironic if the Republicans (with or without McCain) voted en masse against the bailout? And similarly, wouldn’t it be disastrous if the Democrats (with or without Obama) voted en masse for it? Would this be, in fact, the October Surprise all Democrats secretly fear?
2. CEO pay IS a drop in the bucket. Far more important to me, would be a restructuring wherein the Fed LOANS the money to these distressed corporations instead of buying their shitpiles. Wouldn’t that be a far better idea?
3. The best idea would be to postpone the vote at least until the election is over, although a lot would depend on how #1 above shakes out.
Re. Ara’s #2
The issue is debt, both the amount and the quality, adding to the amount really isn’t going to help, imo. The source of the fear driving this thing, from what I can tell, is that the real estate debt is SO bad that it will take down the entire firm because there is so much debt everywhere else. As much as I hate the idea of this bailout, unless someone comes up with a better idea fast, we are stuck with it. The market said ‘yeah, yeah, let’s do that’ as soon as this thing was mentioned. This is now priced in.
Actually, I’d be surprised if the GOP plus the blue dogs don’t kill this thing. They might since that will play back home better unless they believe and can explain the China Syndrome to their peeps. They’ve been riding that anti-socialism thing for far too long. It’s the cornerstone of their Reagan worship.
I’m still holding out for Bin Laden’s head on a platter, served up the day after the last debate as the October Surprise.
I don’t know if any restructuring can occur without valuation of the various pieces of shit in the pile. Their is no market for them right now, thus no true “fair market value.” By definition, therefore, Treasury buying them up is doing so at a premium. And I don’t buy for a minute if the Government sits on them it will recoup it’s money. You saw how well the oil money from Iraq paid for their reconstruction.
I think what needs to happen is once Paulson has the shitpile in his hands, they’ll have to break them appart and trace it all back to the original properties, A lot of that is now in government hands anyway inside Country-Wide, Indy-Bank and Fanny/Freddie. They can then just to a mortgage/security swapout in-house, which should clear out a lot of the unknown and unknowable valuations.
The last thing I want to see are these poisonous securities back out on the open market. You want to buy debt, buy the underlying mortgages so you can preform some due diligence on the likelihood it’ll get paid off eventually. That or put in place a standardized linkage/valuation mechanism designed to eliminate both the toxicity and volatility problems. It won’t be as much fun for the gamblers on Wall Street, but they’ll still have their Hedge Funds.
It’s Doomsday if if they’re told to wait past January.
As for the politics, I don’t think the markets will wait too long. If they only have to put off Armageddon until November 5th, the DOW will take a beating, but China/Japan may hold off pulling the trigger. It will just take that much longer for the recovery. Either way, even if we avoid Depression 2.0, a classic negative growth recession is a certainty. As I said before, I agree with Naomi Klein that we need to use something other than Wall Street’s definition of recession to describe the real economy, because we’re already in a death spiral when it comes to the Misery Index (unemployment plus inflation rates) which has jumped 4 points in the last year.
The Misery Index hasn’t been this bad since Pappy Bush, but it’s been comparable to the middle of the Clinton years throughout Juniors’ term before the housing bubble burst and things started downhill this time last year.
If you chart sharp jumps in the Misery index with classic recessions, you’ll see a sharp jump of almost 4 points or more immediately preceding the ‘73-’74 and ‘80-82 recessions, but there’s really no correlation to any of the Bush recessions, 41’s or 43’s, unless you simply count pushing through 10% combined unemployment/inflation rates. That might be your signal instead of a shock– but it still wouldn’t explain the low Misery Index numbers for the post-9/11 recession. There was an emotional shock then of course, but not a financial one to the degree you see in other classic recessions — and for such a mild quantifiable effect, the recovery was breathtakingly slow.
Unemployment alone is probably the best of the leading indicators, but it can’t tell the whole story all the time, like what happened due to hyperinflation under the 70’s oil embargo which triggered that recession, or the fact that all through the Reagan and GHW Bush years the Misery Index was the nearly the same or higher (sometimes much higher) than it is now, which is as high as it’s been through all of Junior’s Residency. It barely blipped through the 2001-03 post 9/11 recession, probably due to a very aggressive anti-inflation policy by the Fed.
Maybe you can’t quantify it, and the public has been Pavlovian condition to the “R” word so much it’s meaningless. But classic recessions/depressions only measure the business cycle, ignoring the quality of life that really means anything to real people. But don’t go by me. My personal misery index only needs a republican to be elected for it to go through the roof.
Eric:
The issue is debt, both the amount and the quality…
Not sure what you mean by “quality,” but if that means that the equities are effectively worthless, then we agree. All the more reason to not pay a premium for them, which is what the Treasury Dept. is willing to do — with our money!
If the equities are worthless, why are we giving the govt the ok to buy them? And if they are worth something, then I want a piece of the action when they rebound.
Why not put these equities up for auction? Then we might find out what they are really worth, e.g., they are worth what someone is willing to pay for them.
One thing this is NOT is a liquidity problem. It is an asset valuation problem.
The issue has multiple parts: 1) loans made to people without the ability to repay, 2) predatory ARM loans that people didn’t understand, 3) general loss in the value of real estate (which affects people who may have been able to repay their mortgage or sell their house in the previous market) and 4) the bundling and sale of bad and gone bad paper as securities. Unless the NINJA (No Income, No Job) loans make up the lion’s share of the bad debt, which I doubt, then addressing the problem of mortgages which can be salvaged and, by effect, the value of real estate gets to the root of it.
My point about the debt was in reply to your suggestion that we loan them more money. When the markets are concerned with their current level of debt adding to it is not the answer.
There is a huge risk with an auction. The CDOs might not fetch enough money for the banks to survive. If that happens you lose the entry points into the private economy for home loans, car loans, business loans, lines of credit, credit cards, all of the debt. For example, Bank of America just announced that they are suspending loans to McDonalds franchisees for business improvements. One more thought on auctions. Auctions were how these things were traded and what got us into this situation in the first place. The auctions failed.
As to liquidity/asset value, the asset value problem necessarily leads to a liquidity problem. The liquidity problem is the death blow that comes when bank credit ratings are downgraded and they have to raise money that so far does not want to flow into them. All of these banks fund themselves with very short term debt, and by that I mean from overnight loans to 28/64 day loans (all in the range of many, many billions). (I think I’m right about 64 days, but it might be a little longer.) Ratings downgrades also affect banks abilities to access that debt, thus ultimate liquidity problem.
As a way of illustrating the level of panic, the other day on CNBC Jim Cramer was speculating out loud that these (naked) shorting of banks could be a new form of financial based terrorism (ala bin Laden). If you saw that, my apologies for restating it, but I haven’t seen it anywhere outside of financial blogs, certainly nowhere else on TV.
The informal Wall Street term for this is a shit show, very apt.
A bit about the “China Syndrome.”
Being a Canadian, I’ve worked at the Bruce Nuclear Power Plant on Lake Huron in Ontario. At our set of reactors IF the cooling water was lost the nuclear reaction would STOP. The reason US reactors – and many other nations reactors – “melt down” to the ground water level – at which point all holy hell breaks loose is – that the US uses “enriched” uranium – all the easier to get material for BOMBS. Canada – not needing or wanting BOMB material uses “unenriched” material – which is just a lump of uranium.
Makes a man think eh?