It might be useful to review why this year's biggest story, and probably the biggest economic story since 1929--the collapse of international financial markets--came to be. Many analysts have singled out the deflation of the US housing bubble created by deregulation and cheap credit policy as the precipitating cause. That is certainly part of the problem, but many international banks and even countries (Iceland) went bust without large exposures to the US real estate market. This is so because banks and financial institutions traded complex derivative securities over the counter as a means of financing operations, and utilized extreme leverage (as much as 30 times capital) to generate profit. Executives utilizing the radical methodologies were rewarded with outsize compensation packages (see below). Even after their institutions went bust, some fat cats are still collecting their bonuses at taxpayers' expense.The fuse was lit in 2006 when the US housing bubble burst. The financial time bomb exploded in August, 2007 when the financial alchemists realized that the piles of mortgage backed securities were actually worth far less than their mathematical models indicated. Worthless mortgage backed securities are only the beginning of the problem. Credit default swaps normally used to insure against bond defaults were used by speculators to gamble. This derivative market represents $60 trillion in face value, and it is also imploding. Fear induced rigor mortis has set in the credit markets as a result of the sobering realization. Banks do not want to lend to another because no one knows what the securities were really worth, nor are they sure their loans would be repaid. Many banks are left with securities on their books worth less than 50% of their booked value. But because of the extreme leverage employed these banks are exposed to losses of up to 15 times their stated capital value. Bottom line: bankruptcy. Unless that is, you cajole your cronies in Washington to print more fiat currency in exchange for the unmarketable securities you are hiding in your vault.
That in a nutshell is what the government bailout program is doing. The dollar's value will be sacrificed to save the 'Street of Broken Dreams'. Ordinary citizens will suffer a declining greenback, less buying power, and future inflation. Japan made the same mistake in the 1990s by not allowing banks to fail, and thus allowing the market to clear itself of worthless assets in due course. But market fundamentalists are only true believers when their fortunes are not at stake. Variety's headline of 1929 is as good today as it was then. Hard times (for most) are here again[1].[AP photo: Wall Street poster child, ex- Merill Lynch CEO John Thain. Another Merill Lynch exec, Peter Krauss, got a $25 million golden parachute after just three months with the firm when it was bought at a distressed sale by Bank of America. He recently purchased a palatial apartment on Park Avenue for $37 million.]
[1] Consumers are tapped out as a result of the easy credit binge. Household debt has reached $14 trillion up from about $8 trillion in 2000. Real median income has decreased by 1%, and the number of families living in poverty has increased by 19% One estimate is that there will be more than 5,000 foreclosures per day--more than at any time since the Great Depression.