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Generational Dynamics Web Log for 13-Apr-08
Blogger watch: Hellasious at SuddenDebt gets it right

Web Log - April, 2008

Blogger watch: Hellasious at SuddenDebt gets it right

Roubini and the others just play around with alphabet soup.

Over the last couple of years, I've been very critical of the economic bloggers for refusing to face up to the consequences of their own analyses. They would post blog entries telling of disastrous economic data, and then conclude with something like "This might lead us to a recession if we're not super-extra careful." Any comparison to the 1929 crash and the 1930s Great Depression is verboten.

The best and most sophisticated of the economic bloggers, in my opinion, is the Sudden Debt blog, hosted by "Hellasious." Whereas the other economic bloggers are like weather forecasters who look out the window and predict whether or not it's raining, Hellasious has posted very sophisticated analyses of the macroeconomics of the credit bubble and the derivatives market that really make clear how a major worldwide financial crisis cannot be avoided.

So, a year ago I posted a question to him, asking him what he believed the outcome would be, and whether he foresaw a crash, as in 1929. He responded by predicting something similar to the Panic of 1893. This was a very odd response, and it may well have been a joke.

At any rate, last month Hellasious changed his position. In a March 12 posting called "History Rhymes in Slow Motion," he predicted that the current outcome "won't likely be any different" from the crash of 1929. Here's what he wrote:

"The repeated attempts by the Fed to arrest the credit contraction and prevent equity markets from going into a tailspin look to me like a repeat of what happened in October 1929, albeit in extra-slow motion. As an avid student of market history (... "it rhymes"), I highly recommend the careful reading of Galbraith's The Great Crash of 1929.

Within it are described concerted attempts to forestall the inevitable. As the market swooned in late September and early October 1929, "great men" from Morgan and National City Bank were sent to walk the floor of the New York Stock Exchange. They made a grand show of providing money at the broker call-loan post (margin funds) and supporting a variety of blue chips like Steel and Radio with repeated buy orders.

Their actions cheered speculators, who ramped up prices sharply for a few days. But when conditions worsened once again, the "great men" had to give up in order to protect their own institutions.

This time the "action" is taking weeks rather than days to play out, because:

* The "great men" have been replaced by the Fed, which has more resources at its disposal and less inhibitions to using them. It has no shareholders or depositors to protect (except for millions of taxpayers, but that's too amorphous a group) and the man at the helm is stubbornly certain he is following the right course.

* Markets are far more diverse and complex today than the simple stocks, bonds and trusts of 1929. While the overall leverage may in fact be far greater today, there are also more dominoes at play, i.e. more products (e.g. derivatives) and more players (e.g. all sorts of funds). Starting as always with the "bad debt" domino, it takes more time now for the whole series of them to drop before the final "equity" domino is hit a decisive blow.

* After 25 years of successful Fed action that averted or contained financial crises, its abilities have become an article of faith with most speculators, investors and - most unfortunately - politicians. This past performance has created widespread complacency; time and again I hear the same adage from "sophisticated" market participants: "They won't let it get out of hand". The Greenspan put has morphed into the Bernanke put, even though conditions are far more dangerous now.

To summarize, events are proceeding more or less along the same path as 1929 but with more fits and starts. The experience is akin to watching a football game entirely in slow motion - it may take a while to get to the end, but the outcome won't likely be any different."

I jokingly posted a response saying, "Congratulations and welcome to the 'dark side' of the street. I used to be alone over here, but these days I think you'll find that you're in the company of quite a few old friends."

Roubini's 12 steps to financial disaster

Unfortunately, the other economic bloggers are simply stonewalling on the consequences of their own analyses.

The master at this stonewalling is Nouriel Roubini at his RGE Monitor blog. Roubini is a professor of economics and international business at the Stern School of Business, New York University. He's world-renowned, not only because he's a professor, but also because he's been economics adviser to Presidents and other government officials.

Last July I was joking about his bragging that he had predicted a housing recession a year earlier, when this was obvious much earlier.

As early as 2004, I had written that "Real estate is in an overpriced bubble all over the world," and in August, 2005, I quoted Alan Greenspan as saying:

"To some extent, those higher [stock and housing] values may be reflecting the increased flexibility and resilience of our economy. But what [investors] perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums."

There's a lot of finger pointing at Alan Greenspan going on these days, but in fact he called these dangers long before any of these economic bloggers did (though not before I did). So it's silly for any of these economic bloggers to brag about making early calls on these problems, when the problems were already evident years before.

However, Roubini did post a brilliant column on February 5 of this year, called "The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster." His column laid out 12 different dimensions of the global economy that were seriously failing, potentially resulting in a "systemic financial meltdown." In brief, the 12 steps are as follows:

The "worst housing recessing in US history" shows no sign of bottoming out.

Losses from the financial system "from the subprime disaster," especially writedowns of mortgage-backed assets are continuing.

Other forms of unsecured consumer debt, including credit cards, auto loans, student loans, are also increasing.

The "monoline" bond insurers, such as MBIA Inc and Ambac Financial Group are collapsing.

There's an impending meltdown in commercial real estate loans, similar to the meltdown of residential loans that we've been seeing.

There's an expected collapse of "some large regional or even national bank that is very exposed to mortgages, residential and commercial."

The collapse of the leveraged loan market, while good in that it ends financing of "very risky and reckless" leverage buyouts (LBOs), has left these very high risk loans on bank balance sheets.

"Once a severe recession is underway a massive wave of corporate defaults will take place."

The "shadow banking system," composed of SIVs, conduits, money market funds, monolines, investment banks, hedge funds and other non-bank financial institutions, will get into serious trouble. (Since writing this column, Bear Stearns has collapsed.)

US and foreign stock markets "will start pricing a severe US recession," leading to "a cascading fall in equity markets."

A "worsening credit crunch" will lead to a much worse "dry-up of liquidity in a variety of financial markets."

A "vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices will ensue leading to a cascading and mounting cycle of losses and further credit contraction." He adds, "A near global economic recession will ensue as the financial and credit losses and the credit crunch spread around the world. Panic, fire sales, cascading fall in asset prices will exacerbate the financial and real economic distress as a number of large and systemically important financial institutions go bankrupt."

Wow! This is REALLY grim stuff. So what does Roubini think will be the outcome? "A 1987 style stock market crash could occur leading to further panic and severe financial and economic distress."

You've GOT to be kidding! As I explained in "System Dynamics and the Failure of Macroeconomics Theory" and in "How to compute the 'real value' of the stock market," the "false panic of 1987" was fairly brief because the stock market was already underpriced, while the stock market today is overpriced by a factor of almost 250%, same as in 1929.

Alphabet Soup

Last week, on April 7, Professor Roubini wrote a new column, "The US Recession: V or U or W or L-Shaped?" where he introduced what might be called the "alphabet soup recession analysis."

He begins by saying, "Now that there is no doubt that the US is experiencing a recession, the debate is moving towards the length, size and depth of such a recession. Will it be a short and shallow recession or a longer and deeper one?"

This is totally bizarre. In his "12 steps" posting, he talked about "panic, fire sales, cascading fall in asset prices" and "real economic distress as a number of large and systemically important financial institutions go bankrupt." How can he even debate whether this will be a "short and shallow" recession?

He described four different scenarios for the coming US recession, based on four letters of the alphabet:

V-shaped recession: Short and shallow.
U-shaped recession: Longer and deeper recession, lasting around 18 months.
W-shaped recession: A double-dip recession. Like "U", except that the tax rebate will lead to temporary economic growth.
L-shaped recession: A "protracted period of economic stagnation like the one experienced by Japan in the 1990s after the bursting of its housing and equity bubble."

Roubini rejects the L-shaped recession, because "both monetary and fiscal stimulus have started in earnest early on," while they were delayed in Japan. He rejects the W-shaped recession because he doesn't believe that the tax rebate will be sufficiently effective.

He settles on the U-shaped recession, 12-18 months long, based on the following incredible reasoning: "The last two recessions – in 1990-91 and 2001 – lasted 8 months each and today the macro and financial conditions are worse – relative to those two previous recessions."

This reasoning is so bizarre I can barely even address it. How does he arrive at 12-18 months? By comparing it to two previous recessions that had ALMOST NOTHING in common with what's happening today. This is an economics professor who (like Ben Bernanke) has absolutely no grasp of the macroeconomics of a credit bubble, and what the bursting of the credit bubble means.

The other economic bloggers picked up on this "alphabet soup" discussion.

The Calculated Risk blog, in an April 7 posting entitled Roubini on Shape of Recession, says that Roubini is too gloomy. He doesn't use the phrase "W-shaped," but he does say that a "double-dip" is possible. He says that his optimism is based on his belief that he doesn't foresee the severe job losses that Roubini sees, based on the most recent manufacturing employment data.

In Michael ("Mish") Shedlock's blog, in an April 8 posting entitled Case for an 'L' Shaped Recession, Shedlock says that Roubini and CalculatedRisk are not gloomy enough. Shedlock says, "More likely to me is something like an "L" or a "WW" kind of scenario with the U.S. slipping in and out of recession for a prolonged period of time, perhaps 3-4 years or more." He says that economic conditions are worse than Roubini is saying.

I can only shake my head in bewilderment at all these analyses which are, to repeat, the same as a weather forecaster looking out the window and "predicting" whether or not it's raining. There's no recognition of trends, there's no understanding of the global financial system as an integrated system, and there's no attempt to grasp what the bursting of the credit bubble means. It's all just guesswork.

The only one of the major economics bloggers who's getting it right was Hellasious at the Sudden Debt blog.

In an April 9 article, entitled "a + b = \", he writes:

"As even optimistic analysts now believe that a recession is upon us, the debate has shifted to its "lettering": will it be a quickie in-and-out (V), a more prolonged (U), a double-dip (W), or a Japanese version (L) ? My opinion is somewhat different and is not described by a letter, but the - aptly named - slash (\). To wit, I believe we are in for many years of painfully slow contraction, akin to a maddening Chinese drip-drip-drip torture.

The reasons for this view are:

(a) The elements dragging down the economy are deeply-rooted and fundamental. Huge debt, low earned income, zero saving rate, resource depletion and climate change cannot be reversed by a "mild purgative" recession. If left completely unattended, the economy would go into a tailspin (|).

But, at the same time:

(b) Monetary, fiscal and political authorities, steeped as they are in decades of Keynesian and central banking traditions, will be confident of their abilities to cure the economic cycle's weakness. They will keep applying their customary medicines to stop the decline, with some temporary success. If that was all, the economy would go into a flat-line ( _ ) or a slight uptrend (/).

But because of (a), this slowdown virus will prove far too resilient against the usual treatments designed to combat the common economic flu, and the decline will resume until a completely different set of doctors take over and prescribe the necessary radical treatment.

Symbolically, then: a + b = \"

Unlike the other bloggers' analyses, this one actually makes sense from the point of view of generational theory. He says that the problems are "deeply rooted and fundamental," and talks about officials "steeped ... in decades of Keynesian and central banking traditions," and "confident of their abilities" to fix any problem. Those are the people in the Boomer generation, born after WW II, who have no idea what they're doing.

He says that the decline will continue "until a completely different set of doctors take over and prescribe the necessary radical treatment." Those doctors will be like Congress in the 1930s, trying to figure out what happened, and passing new laws to keep it from happening again. By then, it will be too late for a lot of people.

The economics journalists

I'll just briefly mention the economics journalists. They stay out of these debates, except sometimes to say something like, "Über-bear Nouriel Roubini is worried about a recession."

There are two categories of economics journalists:

The Pollyanna journalists. These people, like everyone on CNBC, and Grep Ip at the Wall Street Journal, always spin everything in the most positive way, so that they won't be blamed if there's a fall in the market.

The political journalists. These are like Paul Krugman (on the left) at the New York Times, and Larry Kudlow (on the right) at CNBC. These people put political spin on economics news, and usually end up with stuff that's close to gibberish.

A lot of this stuff is really funny, and I frequently make fun of it on this web site. My favorite is still the day in January when two investment counselors came on CNBC. They said investors are panicking and selling their stocks, and added that people with brain disorders make better investors, because they don't get so emotional. People like these are just good, clean fun.

But something happened this week that really infuriated me.

On April 10, in an event carried by CNBC, Fed chairman Ben Bernanke was answering audience questions on the economy. Then somebody asked a question about whether today's financial conditions are similar to those in 1929, leading to the Great Depression.

The question was, "In the press there have been a number of reports that this has been the most severe economic dislocation since the Depression. As a scholar of the Depression, could you comment on some of the significant similarities and differences ...." At that point, the plug was pulled, and CNBC immediately cut to a commercial break.

Now, one could argue that they were planning to go to a break at that time anyway, but what I believe is that the CNBC producers heard the word "Depression" and freaked out.

CNBC's Pollyanna policies have been richly amusing in the past, but when they actually allow those policies to affect a live news event, they're crossing a line. This behavior is absolutely outrageous.

Here's a link to the video of the 7:25 minute segment. The offending question occurred at the 7:00 point. Judge it for yourself. (13-Apr-08) Permanent Link
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Generational Dynamics Web Log for 13-Apr-08 Blogger watch: Hellasious at SuddenDebt gets it right

Roubini's 12 steps to financial disaster

Alphabet Soup

The economics journalists

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Generational Dynamics Web Log for 13-Apr-08
Blogger watch: Hellasious at SuddenDebt gets it right