economy

10 Sep 2008

Good Times on the Way?

By Alan Thornhill

bag of cash

Now that the Fed has rescued Fannie Mae and Freddie Mac, everything's okay. Right? Alan Thornhill takes a closer look at the state of the US economy

Share traders are having second thoughts about the Fannie and Freddie party. Wall Street initially surged after the US Federal Reserve “rescued” the mortgage giants, Fannie Mae and Freddie Mac. But those early gains were all but wiped out by a slump the following day, as traders took a harder look.

So what happens now?

The Fed certainly did the right thing with its very expensive rescue. It had no choice.

The global economy could all too easily have slipped into recession if it hadn’t. The consequences could have been unthinkable. Our grandparents know how the Great Depression of the 1930s ended: with World War II.

Justice is often pushed aside when emergency strikes and that is certainly happening now. US taxpayers will be left with a bill of at least $US100 billion for this rescue. In the meantime, the mortgage brokers who precipitated the crisis by selling worthless deals to careless lenders escape free. Taxpayers will be left with shares in Fannie and Freddie that they almost certainly would not have chosen themselves. Who, after all, would want to buy shares in institutions like these, which still have so many dud home loans on their books?

One analyst, calling himself hobojaimie, summed it up neatly: “There goes the Baby Boomers’ retirement accounts,” he wrote. “Up in a haze of hallucinogenic smoke. Now they can all roll their upside down mortgages into Fannie and Freddie stock certificates and smoke ‘em, right down to the cockroach.” A cool, if unconventional, assessment.

Civil libertarians, like Phil Gramm, should also be called to account. These simple-minded theorists laid the philosophical foundation for the unrestricted market excesses which produced the still spreading US credit crunch. But Gramm, who was once thought to be a likely Treasury Secretary in a McCain administration, still sees no fault in his free and unregulated market policies. The public is at fault, he claims instead. In Gramm’s view, the US is suffering only from “a mental recession” and Americans have become “a nation of whiners”.

US economist, Paul Krugman, has a different take again. He warns against excessive optimism in the wake of the F&F rescue, arguing that it needs to be seen in “a larger context”. He notes that US house prices have been tumbling since the credit crunch hit a year ago, a phenomenon which has prevented many borrowers in the US paying off heavy debts.

Fancy lending, based on products allied to reverse mortgages, reached much higher levels in the US than in Australia. So a young family signing up for a mortgage on a new house might well have been asked if they would like a new car as well. The extras could be financed at a very cheap rate, the bank manager would say, by adding them on to the mortgage.

When foreign lenders, particularly in Europe and China, began to worry about US debt levels and the ability of US borrowers to repay, the credit crunch became unavoidable.

Krugman compares what is happening in the US now to events in Japan in the late 1980s. He points to the credit crisis there which led to a decade-long slump in the Japanese economy. Furthermore, Krugman notes, “[US] asset prices are still falling: losses are still mounting and the [US] unemployment rate has just hit a five year high. With each passing month, America is looking more and more Japanese”.

He argues that, despite the very expensive rescue of Fannie Mae and Freddie Mac, US authorities may still not have done enough to revive the American economy. The US, of course, is no longer the engine of the world economy but it still plays a very important place.

Right now, confidence in the economy matters for two reasons.

Oil prices fell again, overnight, by some $US3 a barrel. A few weeks ago, a fall like that would have been taken as a sign of likely global recovery, as fuel became cheaper. Last night it was seen as an indication of an imminent downturn in the world economy.

The second signal, though, might ultimately be more important for Australia. Commodity prices have also eased over recent days. And the Australian economy, as we all know, has been running on the commodity boom for years.

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philannetta 11/09/08 4:53PM

It’s difficult to argue that the trouble is over for the US. The recent uptick in the US dollar will shrink its current account deficit fractionally, but it has far deeper structural and geopolitical problems. Economics is still pretty simple at its core, and the US buys far more than it sells – thus the deficit, serviced by borrowings from abroad. To continue this, congress recently raised the debt ceiling to $10.4 trillion. Anyone can see this is unsustainable – a country that was once the world’s biggest lender is now the world’s biggest debtor. Consumer spending makes up around 70% of its GDP, and the consumer is maxed out – no more home equity withdraws, and the credit card industry is starting to suffer as well. Trouble any way you look at it.

There is enough economic potential in the US to provide a standard of living worthy of a developed nation and, probably, to service this growing debt (which will take generations), but not with the level of spending on military and corporate welfare. The US will sink from its current position whichever way it goes – it had a good century with other major powers at war, and with the US dollar as a virtual export stockpiled to pay for commodities, but it tried to prolong its stay at the top through borrowing, and the market is correcting. Now it has to pay. If it adjusts and ploughs money back into rehabilitating its infrastructure, and cancels its foreign adventurism, it might be ok – not what it was, but ok. If not, it will sink far further.

Unless it just decides not to repay its debt, or monetises it to the point that it’s much the same thing. How would the world react to that?

http://philannetta.blogspot.com

douglas jones 12/09/08 11:59AM

douglas jones
This article raises a number of question which the ignorant amongst us would love to have a truthful answer.
For example.
How has the sum at risk become so large so quickly, assuming it is large.Period 2006 - 7 seems to be period of high growth, why?
Was it the belief in the market self correcting or a scam?
Was it excess capital seeking a profitable place to go even talking up that place?
Was it action by interested parties lobbying to have existing regulations relaxed perhaps starting at the time of Thatcher and Reagan?
Were many of these regulation placed following the 30’s depression and designed to avoid similar? Have they bee replaced?
Guilty parties that is those breaking laws have been caught by the FBI in America and those left have simply used legal ways?
Have many new forms of financial articles been created. Leverage put and other options short and long hedge funds take overs?
Simply how has this happened who is responsible who will be punished and who will pay?
Can it be likened to the question of legality hanging over the Iraq war but currently, maybe permanently obscured by the media?

revilo 14/09/08 1:21AM

Maybe the Yanks need something like the regulatory bodies we have here.
The fact that unlicensed "mortgage brokers" got commissions from the banks for selling loans to people who never had the slightest chance of ever even paying the instalments off let alone the principal is an indictment of the American government.
To get a loan here you really have to not need one.
If the lenders sniff that you really need the money you won’t get any, unless you are willing to sell the kids into slavery and eat the dog.
Alvin Toffler the famous futurist has written a number of books which have all proven to be self fulfilling prophecies.: Future shock, where the issues of novelty diversity and transience have led to an unsettling feeling of when the future merges with the present at an alarming rate.
The Ecospasm report (economic rather than ecological) Basically explaining what has been happening in the world financial house of cards, and finally, "The third wave" where the Industrial revolution, the 2nd wave following the Primary agrarian tribal livelihood, fades into the "3rd" wave, a backlash by the environment, in an attempt by "nature" to repel the disease of human overdevelopment and exploitation by literally wiping us from the face of the earth, in massive climactic upheavals.
We can’t say that we have’nt been warned.
Human nature being what it is, will lead to a significant body of influential people remaining in denial,like in the last days of the 2nd WW Berlin in Germany. The partying only stopped once the Allied and Russian forces bombed the crap out of them.
"I think I’m turning Japanese,I’m turning Japanese I really think so…"
We should be so lucky.

Patman 14/09/08 8:35AM

Many Americans have long thought that their economy has been an accident waiting to happen, and have been living in the disaster zone for years now.

The country is billions of dollars in debt, spends kazillions on its defence, and you can decide for yourself which is worse: the Medicare scheme or the US Social Security system.

The US has virtually bankrolled half the world’s economies for years, through fair means or foul; now, in the space of a few years, it’s heading down the same rocky road that befalls all empires. Nothing lasts forever; the US has had it’s day as the premier world superpower.

Mind you, the list of suitors waiting to take over the exalted position of global top dog does not inspire feelings other than nauseous dread: Russia, China, and India.

To quote the immortal one-liner uttered by Eli Wallach during The Good, The Bad & The Ugly:

"One bastard goes in and another comes out."

Take your pick as to which one will come out..